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Classification of Leases

Classification of Leases

A lease is generally clasified into either "finance lease" or "operating lease".

Finance lease

"Finance lease" is a lease whose term is non-cancellable, and in which the lessee pays substantially all the costs of the leased asset.

  • Non-cancelable: The lease contract is non-cancelable over the lease term.
  • Paying substantially all the costs of the leased asset: A lessee pays to a lessor substantially all the cost arising from the lease contract such as acquisition cost of the leased asset, funding cost, personal property tax, and insurance etc..

Under the lease accounting standard, a finance lease is defined as a lease which is non-cancelable and meets one of the criteria below. The details need to be described in the contracts such as lease payments and lease term.

  • The present value of the total lease payments is equal to or more than 90% of the purchase price of the leased asset.
  • The non-cancelable lease term is equal to or more than 75% of the economic life of the leased asset.

Operating Lease

"Operating lease" is a lease other than finance lease.

Maintenance Lease

There are some leases where the lessor itself maintains and repairs the leased asset. This kind of lease is called "maintenance lease". There are many maintenance leases for automobiles which entail burdensome tasks on the owners. A maintenance lease is also classified into either finance lease or operating lease for the purpose of accounting.