What is an operating lease?

An operating lease is a contractual arrangement in which the right to possess and use an asset is acquired for a period of time that is significantly shorter than the asset’s economic life in exchange for periodic rental payment, with the lessor assuming and retaining the risks and rewards of the asset’s ownership.  Any lease that is not a finance lease for accounting purposes is an operating lease.

An operating lease does not transfer to the lessee the risk and reward of ownership of the leased asset nor does it allow the lessor to fully recover the asset’s cost through rental payments, unlike a finance.  The lessor retains ownership of the leased asset and the risk of the residual value at the end of the lease term.  Assets subject to operating leases are presented on the lessor’s balance sheet as property, plant and equipment (PP&E), catagorized according to the nature of the asset.

Lessee Recognition of Rental Payment on Operating Lease
Date	Rental Expense		xxxx
		Cash		xxxx
	To record rental expense incurred on operating lease

Lessor Recognition of Rental Revenue on Operating Lease
Date	Cash		xxxx
		Rental Income		xxxx
	To record income earned on an operating lease

Operating leasing with a contractual period of hours, days, weeks, months or, even, a year is a rental, it generally involving high-volume small-ticket equipment with a liquid second-hand market, such as consumer goods and automobiles.  In addition to rental income, lessors also rely on the residual value of their rental equipment to recover their investment in the leased assets and to earn a profit.  The terms “rental” and “rent”, rather than “lease”, are most commonly used for the short-term operating leasing of equipment and residential real estate.