Operating Lease
A short-term rental agreement where the lessee uses an asset without assuming ownership risks.
What is Operating Lease?
An operating lease is a contractual arrangement where a lessee obtains the right to use an asset for a specified period without transferring ownership or the substantial risks and rewards of ownership to the lessee. Prior to ASC 842 (effective 2019), operating leases were kept off the balance sheet, but under current GAAP all leases with terms exceeding 12 months must be recognized as a right-of-use asset and a corresponding lease liability. Unlike a finance lease, operating lease expense is recognized on a straight-line basis as a single operating expense rather than being split between depreciation and interest charges, resulting in different income statement and cash flow presentation.
Example
A retailer signs a five-year store lease paying $10,000 per month. Under ASC 842, the retailer records a right-of-use asset and lease liability of approximately $551,000 (present value of future payments using a 3% discount rate) on its balance sheet at lease commencement. Each month it records $10,000 as a single operating lease expense — distinct from a finance lease, which would show separate depreciation and interest line items.
Source: FASB ASC 842 — Leases