What is an Operating Lease
Operating lease accounting deals with the treatment of an asset rented by your business under the terms of an operating lease agreement.
An operating lease is an agreement between your business (lessee) to rent an asset from a lessor. The lessor (lease company, finance company etc.) owns the asset, and your business rents the asset in return for a periodic rental payment. Your business never owns the asset, at the end of the term it is returned to the lessor.
Under an operating lease the risks and rewards of ownership remain with the lessor, for accounting purposes the rental payments are simply treated as operating expenses and charged to the profit and loss account on a straight line basis.
Operating leases tend to be used for short term rentals, and the rental period is normally only for a small part of the assets useful life. The lessor would expect the asset to have a residual value at the end of the operating lease agreement. The rental payments do not cover the full cost of the asset and can include other services such as equipment maintenance.
Operating Lease Accounting Example
Suppose a business enters into an operating lease agreement for an asset and agrees to pay rentals of £500 per month.
Operating Lease Accounting Journal Entries
The operating lease accounting entries are completed by recording the rental payments as an operating expense.
The operating lease accounting journal shows cash being used to pay the operating lease rental payment.
In summary, accounting for operating leases is simply a matter of recording the rental payments as operating expenses on a straight line basis. This is in contrast to the more complex capital lease accounting process.