Operating lease
Posted by Rona on March 6, 2012This is defined as a lease other than a finance lease. Operating lease, are not full payout leases as a individual contract does not usually provide the lessor with the required return. The cancellation clause in the lease contract introduces uncertainty in cash flow and leasing of the asset to multiple lessees during its economic life is necessary to recoup the investment and to earn a profit margin. Such leases are also known as non-payout leases.
Example of an Operating Lease
If a lease contract contains the following clauses:
- The lease term is 2 years @ Rs 3,000 lease rental payable at the end of each?year
- The asset will be returned back by the lessee to the lessor at the end of the 2nd year
- The economic useful life of the asset is 5 years
- There is no BPO, residual value losses are borne by the lessee and the lease is not of any?specialized?asset
In this contract, the lease does not secure the lessor the recovery of his capital outlay plus a return, i.e., it does not fulfill the fair value test. The lease is also not for a substantial portion of the economic life of the asset. Other applicable clauses for classifying a lease as finance lease are not fulfilled. Therefore the lease would be considered an operating lease.
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