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Operating Lease

Operating Lease

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Published by: hamarshi2010 on Dec 23, 2009
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09/15/2010

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Operating lease

Operating lease
A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership. It is usually used to get equipment on a shortterm basis.

Since firms prefer to keep leases off the books, and sometimes prefer to defer expenses, there is a strong incentive on the part of firms to report all leases as operating leases. This type of lease is beneficial for businesses who want to keep their leases out of their financial statement.

“operating lease in the financial statements of lessees” The whole of the payments are charged to the profit and loss account. IAS 17 require the rental to be charged on a straight-line basis over the lease term even if the payments are not made on such a basis.

If the term of the lease require a heavy initial payment, a proportion of the payment can be treated as prepaid expense.

Since the lessee does not assume the risk of ownership, the lease expense is treated as an operating expense in the income statement and the lease does not affect the balance sheet. The operating lease does not show up as part of the capital of the firm.

“Operating leases in the financial statements of lessors”

Lessors shall present assets subject to operating leases in their statement of financial position according to the nature of the asset.

The depreciation policy for depreciable leased assets shall be consistent with the lessor’s normal depreciation policy for similar assets, and depreciation shall be calculated in accordance with IAS 16 and IAS 38.

Lease income from operating lease shall be recognised in income on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern in which the benefit from the leased asset is receivable.

The lease can not be recorded as an operating lease if any of the following criterion are met: 1. the lease life exceeds 75% of the life of the asset.  2. there is transfer of ownership to the lessee at the end of lease term.

3.there is an option to purchase the asset at a “bargain price” at the end of the lease term.  4.the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of the fair market value of the asset.

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