You may have been already misunderstood the concepts behind the operating leases. It is because we are dealing with finance leases as well with day to day activities. However, there are some distinguishable characteristics between operating vs finance leases.
Operating lease can be defined as a contract between the owner and the user. But here the user uses an asset of the owner for a short given period without transferring the ownership to the user. In this type of lease, the owner who allows using their asset is named as the lessor, and the user who applies the asset is known as lessee. In businesses, an operating lease is not recorded in the general ledger accounts according to economic theories. Based on the opinions of commerce here the lessor takes residual risk compared to a finance lease.
The lessee does not have any restrictions to use the assets given by the lessor during the short period which is less than the economic shelf life of the asset. However, the maintenance of the asset is carrying out buy lessee during the leasing period whereas the returning condition of the asset should be similar or tally as when it was given initially to the lessee. Unless the lessor can demand the initial quality of the asset when it is given to the lessee through monetary values. Above impairments is like a violation of the operating lease. However, taking good care of the asset along with the rules during the contract period should not be just a legal thing but better to think of it an in an ethical manner.
A real-world example of an operating lease is as follows. Think of a situation where an enterprise needs replacing and renewing their old assets with new ones for specific given periods.
E.g., when an organization or an individual has decided to replace the vehicles twice per ten years within the first quarter, and the lessee or the business organization involves into a series of operating leases to renew their old cars with new ones. Same as automobiles the office essentials like scanning machines, photocopy machines, buildings could refresh continuously.
I’m pretty much sure, that the most popular leases are operating and finance contracts. There are some obvious points that you need to know before involving in an operating agreement. Let’s compare and contrast between finance leases and operating leases.
In finance leases; ownership transfer at the end of the contract, risks, and rewards are with the lessee. So risk management is a must. Lessee has a purchase option for the asset purchasing, running costs and administration expenses are more excellent. But interest, depreciation of rupee value or money the lessor could claim both.
Also, tax incentives do not result in assets or liabilities being recorded on the lessee’s balance payments which improve the lessee’s financial stability.
Operating leases are not capitalized. And also they are in short shelf life compared to finance contracts. The operating rentals are only committed to paying the original cost but, not more than the initial asset cost during the contractual period.
Moreover, the asset needs to be an identified asset whereas in the agreement or the contract the asset needs to be notified for both the parties.
The lessor does not have the right to direct how and for what purpose the asset is going to be used throughout contracted time. The relevant decisions about use are predetermined, and the lessee has the right to operate the given asset during the predetermined period without the consent of the lessor to changing the operating instructions.
Operating leases could be at any periods regardless of the regulations but must be less than the economic shelf life. A short term operational leases are much more effective and safe for the lessor as of the accountability which regards to the impairments with the assets.
Because higher the contracted time between the lessee and the lessor the optimum use of the asset could not be guaranteed. Also with the more significant time period, the conditions of assets like automobiles and office essentials do not get stronger, but gets weaker day by day so although it isn’t the fault of lessee during the contracted time, using the asset if the asset did not work correctly the lessee will be accountable for the failure of the asset.
So finally what I want to conclude is that if you are going to involve in an operating lease better to know the rules, regulations as well as obligations and accountability of the contract before engaging in it because unless it will cause you a loss rather than a benefit.