An operating lease is a short-to-medium-term rental agreement for an asset where the lessee uses the asset for a period shorter than its full useful life. The lessor retains the residual value risk â when the lease ends, the asset is returned and the lessor re-leases or sells it. The business gets the use of the asset without the ownership, and without the long-term commitment of a finance lease.
Key Characteristics
- Short to medium term: Lease term is significantly less than the asset’s useful life
- No ownership transfer: The asset is returned at the end of the lease
- Residual value with lessor: The lender/owner takes the risk (and benefit) of the asset’s value when returned
- Off balance sheet (pre-IFRS 16): Historically treated as operating expenditure, not capitalised. Under IFRS 16 (applicable to large UK companies), most leases are now on balance sheet [VERIFY accounting treatment before publication]
- Flexibility: Easier to upgrade assets at end of term than with hire purchase or finance lease
Operating Lease vs Finance Lease
An operating lease is shorter and does not cover the asset’s full useful life. The key consequence: the lessor retains residual value risk, which may mean lower monthly payments but no option to own the asset at the end.
Typical Uses
- Company cars and vehicle fleets
- Technology (computers, servers) â where assets become obsolete before end of useful life
- Medical and diagnostic equipment
- Assets where regular upgrades are expected
Related Terms
- Finance lease: long-term lease covering the asset’s full economic life
- Hire purchase: instalment purchase leading to ownership
- Contract hire: a common variant of operating lease for vehicles, typically including maintenance