Example of Operating Lease

Example of Operating Lease

A lease which is not a finance lease is considered to be an operating lease. The general condition for the finance lease classification is transfer of risk and reward to the lessee. The operating lease is more like a rental arrangement and rent is charged to the income statement.

For example plant is leased by the ABC & Co for annual rent of $ 2000. The transaction is reflected as under

Date	Particular	Dr.	Cr.
	Rental  a/c	$2,000
	Cash  a/c		$2,000

Example of Operating Lease (Straight Line Bases)

Rental payment is charged to income statement on straight line bases.

Leased plant	2 years
Useful life	10 years
Rental ( at year end)	$ 5,000
Advance payment	$ 2,000

Solution

Step 1. Calculate the annual rent on straight line bases

Step 2. Charge the annual rental to income statement

Step 3. Prepayment if any are accounted for in statement of finance position

Step 1 Annual Rental Calculation

(2 years x $ 5,000)+ 2000/ 2 years

= 6,000 annual rental

Step 2 . Charge annual Rental to income statement

Date	Particular	Dr.	Cr.
	Rental  a/c	$6,000
	Cash  a/c		$6,000

Step 3  Record the prepayment in Balance sheet

The difference between amount paid and the amount charged to the income statement is prepayment and therefore appear as asset in the financial statement.

Total payment  ( $ 5,000 + $ 2000)	$ 7000
Annual Rental	$ 6,000
Balance sheet ( Statement of Financial position)	$ 1000

Total payment includes the advance payment and rental paid during the year. This is important learning point that annual rental paid during the year and rental charge may be differ due to the advance payment because advance payment is also accounted for while calculating the rental expenses for the year.