Leasing involves a contract between a lessor and a lessee giving the lessee possession and use of an asset for an agreed period of time on payment of rentals or other consideration to the lessor. But, within this common principle, there are a number of different types of lease structure. The most significant distinction is between an operating lease and a finance lease.
In practical terms, an operating lease is the kind of lease a person has when hiring an asset for a period significantly shorter than its likely useful life. A person who hires a van for a week is taking out an operating lease as is a train operating company (TOC) that leases a train for the TOC’s seven year franchise period. The typical operating lessor will be a manufacturer or dealer in the assets in question.
A finance lease, by contrast, is in economic substance very close to a loan to purchase an asset, the loan being secured on that asset. Hence, finance lessors are usually members of banking groups. The lease rentals are calculated to ensure that the lessor recoups an amount equal to its capital outlay in purchasing the asset plus interest at a rate sufficient to ensure a profit after deducting its own costs of raising finance.
Guidance on the accountancy and tax treatment of leasing transactions, from the viewpoint of both the lessor and the lessee, is in the Business Leasing Manual.