When equipment is taken on an operating lease, the business does not own the equipment. The lease payment is treated as an expense, not as an asset or a loan. Operating lease payments mainly affect the income statement and current liabilities, not fixed assets.
What Is an Operating Lease?
An operating lease is a short-term or renewable lease where:
- Ownership of equipment remains with the lessor
- Lease payments are charged as rent or lease expense
- The equipment is not shown as asset on the balance sheet
This type of lease is common for construction equipment, machinery, and vehicles used on multiple jobs.
Example: Equipment Taken on Operating Lease
A contractor rents an excavator on a monthly operating lease.
- Monthly lease payment: $2,500
- Equipment is used on multiple construction jobs
- Payment is due at the end of the month
Accounting Treatment of Operating Lease
Income Statement Effect
- Lease payment is recorded as Rent and lease expense.
- Net income decreases by the lease amount
Balance Sheet Effect
- A current liability is recorded until payment is made
- Cash decreases when the payment is made
Equipment Ledger Effect
- Lease cost is charged to jobs using the equipment
- Equipment ledger is updated for cost tracking
Journal Entry Lease Expense Recorded (Month End)
Rent and Lease Expense A/c Dr. 2,500
To Accounts Payable A/c 2,500
(Being monthly operating lease expense recorded)
Journal Entry of Payment of Lease Amount
Accounts Payable A/c Dr. 2,500
To Cash / Bank A/c 2,500
(Being operating lease payment made)
Effect on Financial Statements
Balance Sheet
- Accounts Payable increases when an expense is recorded
- Cash decreases when a payment is made
- No asset or long-term liability is created
Income Statement
- The lease expense of $2,500 is recorded
- Profit decreases by $2,500
Equipment Ledger Entry (Cost Allocation)
Excavator – Rent and Lease Expense 2,500
(Being lease cost charged to equipment usage)
This helps track equipment costs job-wise.
Key Accounting Points
- An operating lease does not create an asset
- Lease payments are treated as expenses
- No depreciation is recorded
- Lease expense reduces profit
- Suitable for short-term or flexible equipment use
Difference Between Operating Lease and Loan Purchase
| Particulars | Operating Lease | Purchase with Loan |
|---|---|---|
| Ownership | No | Yes |
| Asset Recorded | No | Yes |
| Liability | Current only | Long-term |
| Depreciation | No | Yes |
| Expense | Lease expense | Interest & depreciation |
Conclusion
Leased equipment under an operating lease is simple to account for. Lease payments are recorded as expenses, making this method suitable for businesses that want flexibility without owning equipment or taking long-term loans.
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