Distinguish between operating leases and financial leases. Would you be more likely to find an operating lease employed for a fleet of trucks or for a manufacturing plant?

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Distinguish between operating leases and financial leases. Would you be more likely to find an operating lease employed for a fleet of trucks or for a manufacturing plant?

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Distinguish between operating leases and financial leases. Would you be more likely to find an operating lease employed for a fleet of trucks or for a manufacturing plant?

Explanation & AnswerSolution by a verified expert

Explanation

The following points differentiates a financial lease from an operating lease:

Under financial lease agreement, the ownership of the asset is transferred from the lessor to the lessee at the end of the lease term whereas under operating lease agreement, the ownership of asset is not transferred to lessee, the asset is returned to the lessor at the end of the lease term.
In a financial lease, the administration and maintenance costs of the asset are borne by the lessee in a financial lease whereas in operating lease, the administration and maintenance costs are borne by the lessor.
The financial lease covers a major part of the economic life of an asset whereas the term of the operating lease agreement ends much before the economic life of the asset and the lessor can lease the asset to another lessee for the remaining life of the asset.

 
Fleet of trucks is more likely to be employed by an operating lease as a fleet of trucks will require large capital for its purchase at the end of the lease agreement in case it opts for a financial lease and a firm may not be able to finance such large amounts. Moreover, leasing the fleet allows the firm to operate newer models with the later fuel savings and safety upgrades. However, a manufacturing plant is likely to be employed by financial lease as the companies prefer to purchase the machinery at the end of the agreement in case it results in profit for the business.

Verified Answer

A financial lease is an agreement where the lessee is allowed to use the asset during the agreement and is given the ownership of the asset as the agreement ends but operating lease allows the lessee to use the lessor's asset during the agreement without transferring the ownership of the asset at the end of agreement.
Moreover, an operating lease contains a cancellation clause but a financial lease does not contain a cancellation clause.
Further, the financial lease lasts for almost the whole of the estimated life of the asset whereas operating lease ends much before the end of the estimated life of the asset.
 
An operating lease is more likely to be employed for a fleet of trucks as compared to a manufacturing plant because a fleet of trucks requires large capital for its purchase as well as more likely to undergo technological upgradation as compared to the manufacturing plant. The firm may not be able to finance such large amounts to purchase the fleet of trucks, so it should employ operating lease as an operating lease does not require the purchase of equipment at the end of the agreement and provides a cancellation clause which helps the lessee to cancel the lease in case the lessee needs upgraded trucks for fuel savings and safety measures.

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