Operating Lease Journal Entry
A lease is an agreement between two parties, the lessor (the owner of the asset) and the lessee (the user of the asset), where the lessor agrees to allow the lessee to use the asset for a specified period of time in return for payment.
There are two main types of leases: operating leases and finance leases.
Operating leases are leases that are not considered to be a form of financing. The lessee does not have the right to purchase the asset at the end of the lease term, and the lease payments are typically lower than the payments that would be made on a loan. Operating leases are classified as liabilities on the lessee’s balance sheet.
Here are some key characteristics of operating leases:
- The lessee does not have an option to purchase the asset at the end of the lease term.
- The lease payments are typically lower than the payments that would be made on a loan.
- Operating leases are classified as liabilities on the lessee’s balance sheet.
Finance leases are leases that are considered to be a form of financing. The lessee has the right to purchase the asset at the end of the lease term for a nominal amount, and the lease payments are typically higher than the payments that would be made on a loan. Finance leases are classified as assets on the lessee’s balance sheet.
Operating Lease Journal Entry
For operating leases, the rental fee is recorded as an expense on the income statement over the lease term. This is because the lessee does not own the asset, and the lease payments are simply for the use of the asset.
The rental fee is typically recorded as a straight-line expense over the lease term. This means that the same amount of expense is recorded each year for the duration of the lease.
However, the rental fee can also be recorded as a declining balance expense. This means that the amount of expense recorded each year decreases over the lease term.
The method used to record the rental fee will depend on the specific terms of the lease agreement.
The rental expense is recorded as expense and credit cash paid to landlord.
| Account | Debit | Credit |
|---|---|---|
| Rental Expense | XXX | |
| Cash / Payable | XXX |
Difference Between Operating Lease and Finance Lease
Here are some key characteristics of finance leases:
- The lessee has an option to purchase the asset at the end of the lease term for a nominal amount.
- The lease payments are typically higher than the payments that would be made on a loan.
- Finance leases are classified as assets on the lessee’s balance sheet.
The main difference between operating leases and finance leases is the way that they are accounted for. Operating leases are classified as liabilities on the lessee’s balance sheet, while finance leases are classified as assets. This difference in accounting treatment can have a significant impact on a company’s financial statements.
Here is a table that summarizes the key differences between operating leases and finance leases:
| Feature | Operating lease | Finance lease |
|---|---|---|
| Ownership of asset | Lessee does not own the asset | Lessee owns the asset |
| Option to purchase asset | Lessee does not have an option to purchase the asset | Lessee has an option to purchase the asset for a nominal amount |
| Lease payments | Lease payments are typically lower than the payments that would be made on a loan | Lease payments are typically higher than the payments that would be made on a loan |
| Accounting treatment | Operating leases are classified as liabilities on the lessee’s balance sheet | Finance leases are classified as assets on the lessee’s balance sheet |
Benefits of Operating Lease
Those are some of the benefits of operating leases. Here are some additional benefits:
- Flexibility: Operating leases offer more flexibility than finance leases. This is because the lessee does not have to make a down payment, and the lease payments are typically lower than the payments that would be made on a loan. This makes operating leases a good option for businesses that need to finance assets but do not have a lot of cash on hand.
- Liquidity: Operating leases can help businesses improve their liquidity. This is because the lessee does not have to make a down payment, and the lease payments are typically lower than the payments that would be made on a loan. This frees up cash that can be used for other purposes, such as investing in new products or services.
- Off-balance sheet financing: Operating leases can be classified as off-balance sheet financing. This means that the lease payments are not reflected on the lessee’s balance sheet. This can be beneficial for businesses that want to improve their financial ratios.
Here are some of the drawbacks of operating leases:
- The lessee does not own the asset: The lessee does not own the asset that is being leased. This means that the lessee does not have the same control over the asset as if they owned it. For example, the lessee may not be able to make modifications to the asset without the lessor’s permission.
- The lessee is responsible for maintenance and repairs: The lessee is typically responsible for maintenance and repairs on the asset that is being leased. This can be a significant cost, especially if the asset is complex or requires a lot of maintenance.
- The lessee may have to pay for early termination: If the lessee needs to terminate the lease early, they may have to pay a penalty. This can be a significant cost, especially if the lease term is long.