Finance Lease or Operating Lease? Which is which and why should I be bothered which one I use?
It is commonly accepted that leasing is a good way to finance the purchase of assets, whether that be equipment, soft assets (fixtures/fittings) or a new system to be installed in your premises (air-con, solar panels).
The question then arises over what type of lease to go for (also consider all types of finance).
The Differences between Finance Lease and Operating Lease
Let’s look at the generally accepted accounting definitions (either SSAP21 or IAS17) which defines an Operating Lease as ‘ a lease other than a Finance Lease’. This means if we can define a Finance Lease then we have our answer, so her goes…
SSAP21 (the accounting standard of practice) defines a finance lease as a lease that transfers ‘substantially all of the risks and rewards of ownership of the asset to the lessee’.
This means that the lessee (the borrower) is practically in the same position as if they had paid cash and owned the asset.
The lessor (the finance lease provider) charges a rent as for the hiring of the asset to your business. The lessor retains ownership, however the lessee then gets exclusive use of the asset (within the set terms of the finance lease).
The lessee pays rentals that cover the original cost of the asset during the period of their lease. An obligation to pay all of these rentals exists, in addition there is sometimes a balloon payment at the end. Once paid the lessor will have then received the same funds as it invested in the asset.
The business is committed to paying these rentals, therefore a finance lease is commonly described as being non-cancellable. That said some finance lease providers do offer cancellation options.
The advantage to a finance lease over operating lease is that a finance lease is ‘on balance sheet’ meaning the liability shows, this also means that the full cost of the rentals can be put through as a taxable expense, meaning you repay before corporation tax.
As with anything with regard taxation of treatment of payments, please always refer to your accountant, don’t use our blog as your justification to HMRC. We are only trying to help…
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By Dave Farmer
You really give some great information here. Financial lease is a situation in which a finance company or other lessor purchases an asset, then leases that asset to a client or lessee for a specified amount of time. At that point, the client takes possession of the asset and is free to utilize the asset for the duration of the lease agreement.