The Accounting Problems of Financial Leasing

Financial leasing is an important option that is available to individuals and organizations to lease equipment and fixed assets. However, this type of contracts involves some accounting problems that they must know.

First, they shall check the credibility of the lessor and the financial leasing company as this affects the final quality of the service and the amount agreed upon.

Second, long-term contracts require series of payments which constitute a financial burden for the lessee. Consequently, they shall choose the option that fits their financial conditions.

Third, they should thoroughly review the financial leases to ensure that information is properly recorded as it impacts the financial management and taxation.

Financial leasing contracts are one of the important means of financing for companies and individuals; however, they demand the attention of financial and accounting authorities. Among the accounting problems of lease contracts is determining whether the lease is an operating lease or a finance lease. This depends on the nature of the contract according to the accounting standards (EAS 20). 

The main differences between finance lease and operating lease

1-        In a finance lease, the contract is long-term, almost the life of the asset, while an operating lease is a short-term contract and doesn’t exceed the period in which the lessee needs the asset to perform a particular job, and it shall normally be renewed annually.

2-       In a finance lease, all the risks and rewards of ownership are transferred to the lessee. On the other hand, in an operating lease, risks and rewards of ownership remain recognized by the lessor.

3-       In a finance lease, the lessee is liable for the depreciation of the asset, while in an operating lease the lessor is liable for the asset’s depreciation and all the risks involved.

4-       In a finance lease, the lessee is liable for the maintenance costs, as well as insurance costs during the contract period. In an operating lease, on the contrary, the lessor is liable for all costs of maintenance, repairs of the asset and insurance costs.

5-       For a finance lease, the lessee has the right to choose between three alternatives (return the asset to the lessor or re-lease it for another period or purchase it), whereas the lessee in an operating lease may not own or purchase the asset, but the only alternative is to return the asset to the lessor at the end of the lease period.

Ø  There are also some other problems:

o    The lease payments that are broken down among financial periods requires knowing the nature of the financial benefits and determining the main installment and interest. This demands knowing the lease principle. 

o    The impact of the lease on the balance sheet and expenses associated with the lease contract. In addition, the lease may affect future financial rates and result in losses, and therefore accountants must carefully examine the financial and accounting risks of the contract.

o    Accounting problems may arise in financial leasing if expenses and payments are not properly managed as this leads to unequal revenues and costs. Also, there may be an error in accounting or in the recording of the lease contract, which adversely affects the validity of the company's budget and financial statements.