Finance or Operating Lease?

A lease is an agreement between the lessor (the owner of an item) and a lessee (the one who wants the item).

There are two types of leases: operating leases and finance leases.

It's very important to be able to look at a lease and categorize it appropriately, because they are recorded differently.

Every lease is considered an operating lease by default, unless one or more of the following conditions are met:

1. Transfer of ownership - The lessee gets title to the item (during or after the lease).
2. Bargain option - The lessee is guaranteed the option to purchase the item at a very low price when the lease ends.
3. Lease term - The lease lasts at least 75% of the item's lifetime.
4. Present value - The present value of the lease payments is at least 90% of the value of the item.
5. No alternative use - The item is so specialized that the lender won't be able to find any other use for it after the lease.

👉 Answer:

👨‍🎓 Here are the steps to figure it out:

• If the present value of the lease payments is < 90% of the item's value, it can be an operating lease.