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Operating Lease in Accounting: Definition, Calculation & Example

Operating Lease in Accounting: Definition, Calculation & Example
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  • 0:00 What is an Operating Lease?
  • 2:00 Businesses and…
  • 3:30 Accounting for an…
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Lesson Transcript
Instructor: Ryan Hultzman
In this lesson, we will identify the nature of leases, the requirements that must be met to treat a lease as an operating lease, and how to account for an operating lease.

What Is an Operating Lease?

A lease gives you the right to use an asset for a certain period of time. In a lease, someone makes a monthly payment for as long as they have the right to use the asset. An operating lease is a lease that allows you to use an asset but doesn't give you the benefits usually associated with ownership. Accounting rules are very specific as to the criteria that must be met for a lease to be considered an operating lease. An operating lease is one that doesn't violate any of the following four rules or criteria established within accounting standards:

  • Use the asset for less than 75% (or 3/4) of its useful life.

Suppose a business leases company cars for its sales force. If these cars have useful lives of 10 years and the companies leases them for 8 years, then it has the benefit of using them for 80% of their useful life. Another buyer would only get 2 years use of the car. That second buyer is basically getting a second-hand car. Clearly, the first business owned the car even though they called it a lease.

  • Have ownership remain with the lessor at the end of the lease.

Ownership transferred at the end of the lease cannot happen because the title must remain with the lessor. You cannot be given a title of ownership with an operating lease.

  • Not allow you to purchase the asset at a bargain price at the end of the lease.

If you can get it the leased item at a big discount at the end of the lease, then you own it. It's not an operating lease.

  • Result in paying less than 90% of what the asset is worth on the open market.

If your lease payments result in you paying at least 90% of what it's worth, then you own it. It's not an operating lease.

Provided a business doesn't violate any of those rules, then they would be able to account for the lease as an operating lease. The intent of the parties executing the contract is not a factor. What matters are the terms that are included in the contract.

Businesses and Operating Leases

Some leases require an up-front down payment. Businesses that need access to assets, such as cars, equipment, and buildings, but don't want to own them may decide to lease them from another company. There are several other reasons businesses may find it necessary to enter into operating leases:

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