Week 1 Discussion 1:

What is a lease?  Explain the difference between an operating lease and a finance lease?

Week 1 Discussion 1: What is a lease?-Sample Solution

Differences between Operating and Finance Lease

Differences between Operating and Finance Lease

A lease is a form of asset financing involving an agreement between a lessor and a lessee in which a lessee is expected to pay lease rentals for using an asset owned by a lesser (Gao, 2018). The lessor reclaims the asset at the end of the leasing period. Notably, there are two types of leasing: operating and financial. Gao (2018) explains that a financial lease refers to contractual agreements whereby the lessor lease assets to the lessee for more extended periods. The lessee uses the asset for most of its useful life.(Operating Vs Finance Lease Essay-Example)

On the other hand, an operating lease refers to a contractual agreement whereby the lessor leases an asset to the lessee for shorter durations which attract periodic payments. The lessee uses the asset for a shorter part of its valuable time before returning it to the lessor. Another difference is that in an operating lease, the lessor is responsible for maintaining and caring for the asset throughout the contracted period (Brigham & Ehrhardt, 2019). In this case, the lesser bears the risk of obsolescence. On the contrary, in a financial lease, the lessee bears the responsibility of caring for and maintaining the asset throughout the lease period. It includes bearing the risk of obsolescence of the asset.

Financial leases allow the less(Operating Vs Finance Lease Essay-Example)ee to acquire asset ownership by making residual/balloon payments to the lessor at the end of the leasing period. On the contrary, Brigham and Ehrhardt (2019) explain that an operating lease does not allow for residual payments since it involves shorter durations. Also, financial leasing based on primary terms cannot be reversed, except when considering exceptions (Gao, 2018). On the other hand, operating leasing can involve cancellations during the primary terms. Lastly, in a financial lease, the lessee assumes an asset ownership loan agreement, while in operating leases, the lessee assumes asset ownership through a rental agreement. (Operating Vs Finance Lease Essay-Example)

References

Brigham, E. F., & Ehrhardt, M. C. (2019). Financial Management. Mason, OH: Cengage. (16th ed., pp. 779-802). Mason, OH: Cengage. http://www.worldcat.org/oclc/1202460115

Gao, S. S. (2018). International leasing: Strategy and decision. Routledge. https://doi.org/10.4324/9780429451850