What is an Operating Lease
Operating lease accounting deals with the treatment of an asset rented by a business under the terms of an operating lease agreement.
An operating lease is an agreement between the business (lessee) to rent an asset from a lessor. The lessor (lease company, finance company etc.) owns the asset, and the business rents the asset in return for a periodic rental payment. The business never owns the asset, at the end of the term it is returned to the lessor.
Under an operating lease the rights and risks 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 a rental of 3,000 for a six month period.
The lease rentals are recognized uniformly over the term of the lease. In this example, the rental expense for each month is calculated as follows.
Rent per month = Total rental expense / Term in months Rent per month = 3,000 / 6 = 500
Operating Lease Accounting Journal Entries
The operating lease accounting entries are completed by recording the rental payments as an operating expense.
| Account | Debit | Credit |
|---|---|---|
| Rental expense | 500 | |
| Cash | 500 | |
| Total | 500 | 500 |
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.