What are the two major types of leases? Discuss the advantages and disadvantages of leasing.

Question

What will be an ideal response?

Answer 1

There are two basic types of leases, operating leases and capital leases. The two types of leases differ primarily in how the property is disposed of at the end of the lease period.
Operating leases are leases that are similar to renting. In an operating lease, ownership of the asset never passes to the lessee. At the end of the lease period, the asset is either returned to its owner, or purchased at its then current fair market value.
Capital leases are leases that are essentially the same as buying the asset. At the end of the lease period the asset becomes property of the lessee, either without any additional payment or by the lessee paying a nominal amount. The test to determine if a lease is a capital lease, rather than an operating lease, is the existence of provisions for title of the asset to pass to the lessee at a price less than the asset's fair market value.
The benefits of leasing are: One can usually obtain a very low down payment. Second, the process of negotiating and closing a lease is usually less complicated and expensive than making a purchase and obtaining borrowed funds. A third benefit is that it is usually much easier for one to replace leased assets than it is to replace assets one owns.
The primary disadvantage of leasing is that it usually costs more than would purchasing. A secondary disadvantage is that leased assets are usually subject to numerous restrictions on how they may be used, maintained, and disposed of. Restrictive lease covenants are intended to provide protection to the owner by preventing the lessee from allowing the asset to lose value through misuse, neglect, or abuse.