This article throws light upon the top two types of lease. The types are: 1. Operating Lease 2. Financial Lease.
Type # 1. Operating Lease:
An operating lease is usually characterised by the following features:
(i) It is a short-term lease on a period to period basis. The lease period in such a contract is less than the useful life of the asset.
(ii) The lease is usually cancelable at short-notice by the lessee.
(iii) As the period of an operating lease is less than the useful life of the asset, it does not necessarily amortize the original cost of the asset. The lessor has to make further leases or sell the asset to recover his cost of investment and expected rate of return.
(iv) The lessee usually has the option of renewing the lease after the expiry of lease period.
(v) The lessor is generally responsible for maintenance, insurance and taxes of the asset. He may also provide other services to the lessee.
(vi) As it is a short-term cancelable lease, it implies higher risk to the lessor but higher lease rentals to the lessee.
Operating or service leasing is common to the equipment’s which require expert technical staff for maintenance and are exposed to technological developments, e.g., computers, vehicles, data processing equipment’s, communication systems, etc.
Type # 2. Financial Lease:
A lease is classified as financial lease if it ensures the lessor for amortisation of the entire cost of investment plus the expected return on capital outlay during the term of the lease. Such a lease is usually for a longer period and non-cancelable.
As a source of funds, the financial lease is an alternative similar to debt- financing. Most of the leases in India are financial leases that are commonly used for leasing land, building, machinery and fixed equipment’s, etc.
A financial lease is usually characterised by the following features:
(i) The present value of the total lease rentals payable during the period of the lease exceeds or is equal to substantially the whole of the fair value of the leased asset. It implies that within the lease period, the lessor recovers his investment in the asset along with an acceptable rate of return.
(ii) As compared to operating lease, a financial lease is for a longer period of time.
(iii) It is usually non-cancelable by the lessee prior to its expiration date.
(iv) The lessee is generally responsible for the maintenance, insurance and service of the asset. However, the terms of lease agreement, in some cases, may require the lessor to maintain and service the asset. Such an arrangement is called ‘maintenance or gross lease’. But usually in an operating lease, it is the lessee who has to pay for maintenance and service costs and such a lease is known as ‘net lease’.
(v) A financial lease usually provides the lessee an option of renewing the lease for further period at a nominal rent.