Financial and Operating Lease - Essay Example

There are two main types of leases namely; financial and operating leases.  A financial lease is where the company possesses the asset throughout the lease period; the lessee may not sell the property during the period of a lease. On the other hand, an operating lease involves a lease that is utilized if the asset has a resale value, the lessor carries out the risk associated with the lease till the end of the period (Stevens,p.188).

Commercial lease agreement such as real estate involves the following components: names of the tenant involves the first and the last names of the tenant. The lease agreement also involves the terms of the lease. The lease term is the length of time/time frame when the contract between the lessee and the lessor is expected to expire, upon which the lessee may renew the agreement. Another component involves rent to be paid. The amount of rent that the tenant (lessee) should pay to the landlord (lessor) should be clearly be specified as well as the due date for payment. In addition, the responsibilities of the parties involved in a lease agreement should be clearly be defined to avoid conflict between the lessee and lessor. For example, it should explain when and who should make repairs to the premises or the property. The intended use of the property should be clearly be stipulated in the agreement (Martikainen, Kimmo and Jenni, p.95).

 There are various financial benefits that may accrue to a business for leasing property. Among those benefits include: lease may allow a business with less capital to grow because it allows the business to use lease property to earn profits. In addition, a lease helps an organization to secure its cash flows by paying for the property as it earns profits. Deprecation of equipment is treated differently in financial reports. In addition, lease payment has different tax treatment. For example, lease payments are treated as expenses when preparing financial statements. This becomes advantageous to the business as they are set off against profits.

Finally, a lease enables the business to be more flexible because a business is not obliged to renew the lease at maturity. However, a lease has some limitation which includes but are not limited to; a lessor may ask the lessee to increase rental payment upon the renewal of the lease if the business is excelling. Some leases may shift all maintenance costs to the lessee which might be very unfavorable to the tenant. Finally, circumstances may dictate a business to change its operation which may amount to termination of the lease agreement. This might be too expensive for the affected business (Mancini, p.58).