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There are two principal parties in a lease arrangement:
- Lessee – The person or entity that acquires the right to use the asset by paying an agreed amount to the lessor.
- Lessor – The person or entity that owns the asset and grants the right of usage to the lessee in return for payment.
Leasing provides an alternative to purchasing an asset outright. It offers advantages to both parties — the lessor, who earns income through leasing as part of their business, and the lessee, who can use the asset without making a significant initial investment. This makes leasing a cost-efficient and flexible option for organizations that require assets temporarily instead of permanently owning them.
Types of Leases
1. Operating Lease
2. Finance (or Financial) Lease
Depending on the terms and duration, a lease can resemble either a rental agreement or a purchase arrangement.
1. Operating Lease
An operating lease is a short-term contract where the ownership and most of the associated risks and rewards remain with the lessor. The lease period is generally shorter than the asset’s total useful life.
Example:
If a machine with a useful life of 20 years is leased for just 2 years, it would qualify as an operating lease.
2. Finance Lease
A finance lease (also referred to as a capital lease) is a long-term arrangement that is similar to purchasing an asset. Under this type of lease, the lessee bears most of the risks and enjoys most of the benefits related to ownership. The lease term usually covers a significant portion of the asset’s useful life.
If a motorbike with a useful life of 15 years is leased for 14 years, the agreement would be considered a finance lease.
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