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In your opinion, does this difference matters to a financial manager?
In Finance Lease or Capital lease, ownership of the asset is transferred from lessor to lessee. But in operating lease, transfer of ownership does not occure.
So, in Finance Lease you own the asset after getting into the lease agreement. So, you need to show the asset in Balancesheet, depreciate it over its life period and the depreciation value must be expensed in P&L A/c. But in Operating Lease, only lease rentals will be expensed in P&L A/c and Balancesheet won't be affected.
Suppose that firm A and B are from similar industry. "A" acquired asset on Finance lease and firm B on Operating lease. Both are enjoying same benefits from machinery, but
1. Firm A will report lower Asset Turnover Ratio, B will report higher Asset turnover
2. Firm A will report lower ROC (Return On Capital Employed), firm B will report higher
3. Firm B will be considered more efficient than firm A
4. Suppose, there is a sudden change in technology and the asset become obsolate, firm A will have to write-off entire value of the machine. But firm B will not be affected
Organisation's often choose to lease long-term assets rather than buying them. The decision to lease is mainly based on certain factors like necessity, better financial terms, keep the assets off the balance sheet, or the lack of available funding. Operating lease and finance (capital) lease are the two kinds of accounting methods for leases. Both kinds of leases are used for different purposes and results in differing treatment in the books of accounting. Operating lease are treated as expenses where as a finance lease is included as an asset for the lessee.
