Question 5 OR (b)
Operating lease and finance lease
6 marks
- Time to write
- About 12 minutes
- Topic
- Leases and AS 19
- Notes
- Crux notes
Question
Question 5 OR (b) · 6 marksDifferentiate operating lease with financial lease.
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Write it in this order
- Read; underline the asks; jot your points 1 min
- 1 The deciding test: transfer of risks and rewards AS 19 2 marks 3 min
- 2 Differences in nature, term, cancellation, maintenance, obsolescence, purchase option 3 marks 5 min
- 3 Accounting difference in the lessee's books 1 mark 2 min
- Check: every ask answered, key terms underlined 1 min
Short on time? Trim steps 1 and 2 evenly rather than skip one: each is capped at its own marks. End with step 3 in a line or two.
Try it first. About 12 minutes for 6 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
The deciding test. Under AS 19 “a finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset” (AS 19, para 3.2); an operating lease is any other lease. Which one a lease is depends on the substance of the transaction rather than its form. (The paper's "financial lease" is the finance lease.)
1The press is signed over for nearly its whole life—oiling, repairs and all are the lessee's now.
Finance leaseA lease that transfers substantially all the risks and rewards incident to ownership of an asset
2The laptops come like a rental: used for the season, then carried back out the door.
Operating leaseLike a rental agreement
| # | Basis | Finance lease | Operating lease |
|---|---|---|---|
| 1 | Risks and rewards of ownership | Substantially all transferred to the lessee | Not transferred; they stay with the lessor |
| 2 | Nature | A kind of loan agreement, with the lessor as financier | Like a rental agreement |
| 3 | Lease term | Long: covers most of the asset's economic life | Short compared with the asset's economic life |
| 4 | Cancellation | Not cancellable by the lessee | Can be cancelled before the lease period ends |
| 5 | Repairs, maintenance, insurance | Borne by the lessee | Borne by the lessor |
| 6 | Risk of obsolescence | Borne by the lessee | Borne by the lessor |
| 7 | Option to buy | Usually gives the lessee an option to purchase | No option to buy during the lease |
| 8 | Accounting by the lessee | Asset and liability recognised at inception (at fair value, or the present value of the minimum lease payments if lower); depreciation and a finance charge follow | Lease payments charged as an expense, normally on a straight-line basis; no asset or liability recognised |
| 9 | Typical assets | Costly assets: plant and machinery, buildings, aircraft | Cars, computers, office equipment |
Sources for the table. Rows 1 to 7 and 9 follow the DU text's comparison of the two kinds of lease and its list of the features of each, including that a finance lease is not cancellable by the lessee and an operating lease is. Row 8 follows AS 19: a lessee recognises a finance lease as an asset and a liability at inception, and recognises operating lease payments as an expense on a straight-line basis.
Where the 6 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | The deciding test: transfer of risks and rewards (AS 19) | 2 |
| 2 | Differences in nature, term, cancellation, maintenance, obsolescence, purchase option | 3 |
| 3 | Accounting difference in the lessee's books | 1 |
| Total | 6 |
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