Under this category we have 2 forms of leases
FINANCIAL OR CAPITAL LEASE
A finance lease is a longterm lease. A lease is regarded as a capital lease if it meets any one of the financial conditions.
It transfers title of the asset to the lessee by the end of the lease period.
The lease contains an option to purchase the asset at the end of the lease period at a bargain price.
The lease period is equal to or greater than 75 percent of the estimated economic life of the asset.
At the beginning of the lease period, the present value of the minimum lease payments is at least 90 percent of the fair value of the leased property to the lessor (less any investment tax credit realized by the lessor).
OPERATING LEASE OR SERVICE LEASE
These are short term and they give the lesser the right to use the leased property but they do not give the lessee all the benefits that are associated with ownership. The lease does not meet conditions of financial lease.
Additional conditions of an operating lease are:
- Operating lease includes both financing and maintenance services. The lease ordinarily calls for the leasor to service and maintain the lease.
- Operating leases are not fully amortized. The lease contract is written for substantially less than economical life of the asset.
- Operating Lease has a cancellation clause, giving the leasor the right to cancel the lease before expiration of initial agreement.