Operating Leases

From a financial reporting perspective, an Operating Lease has the characteristics of a usage agreement and also meets certain criteria established by the Financial Accounting Standards Board (FASB). Such a lease is not required to be shown on a balance sheet of the lessee. The term is also used to refer to leases in which the lessor has taken a significant residual position in the lease pricing and, therefore, must salvage the equipment for a certain value at the end of the lease term in order to earn its rate of return. The criteria for meeting FASB 13 classification of an operating lease are:

  • Title for the equipment does not automatically transfer to the lessee during or by the end of, the lease term.
  • There is no bargain purchase price.
  • The noncancellable lease term is lesser than 75 percent of the asset's economic life.
  • The present value of the minimum lease payments, discounted at the lessor's interest rate implicit in the lease, is the lesser than 90 percent of the leased asset's Fair Market Value.