Leasing

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Leasing is a popular form of financing. There are 2 types of leases, operating and finance lease.

For clarification, the lessee is the user of the asset while the lessor is the financier of the asset.

In operating lease, the lessor owns the asset and is responsible for its maintenance and insurance. The contract may be cancelled and the asset goes back to the lessor. The lessee recognises the lease payments in its P&L. That’s all the effect on the company’s financial statements. Typical assets leased are photocopying machines, computers and automobiles (not to be confused with HP for cars).

In a finance lease, the lessee owns the asset and is responsible for its maintenance and insurance. This is akin to the company borrowing money from a bank to buy the asset. The asset appears in the lessee’s balance sheet and is depreciated. The lease payments are discounted at the lessee’s borrowing cost and appear as a liability in the lessee’s balance sheet. Assets leased include buildings and aircraft.

Hence, a company will choose finance lease if it wants to report a bigger balance sheet. If it doesn’t want to have a high gearing (debt), it will choose operating lease.