Some Cross-Cutting Issues 313
ownership of the asset. Financial leases can apply
to all non fi nancial assets, including natural re-
sources under some circumstances.
A4.5 Th e following paragraphs discuss the treat-
ment of operating leases, fi nancial leases, and re-
source leases in detail.
Operating leases
A4.6 Operating leasing is the activity of renting
out produced assets under arrangements that pro-
vide use of a tangible asset to the lessee, but do not
in volve the transfer of the bulk of risks and rewards
of ownership to the lessee. Th e legal and economic
owner is called the lessor. One indication that an op-
erating lease exists is that the responsibility for repair
and maintenance of the asset lies with the legal owner.
Under an operating lease, the asset remains on the
balance sheet of the lessor.
A4.7 Amounts payable under an operating lease
for the use of the asset are referred to as rentals and
are recorded as payments for a service. In principle,
any fi xed asset may be subject to an operating lease.
Th e character of operating leases may most easily be
de scribed in relation to fi xed assets since operating
leases oft en concern vehicles, offi ce equipment (e.g.,
photocopiers), construction equipment, buildings,
etc. Th e service provided by the lessor to the lessee
goes beyond the mere provision of the asset. It in-
cludes other elements, such as the convenience for
the lessee that the lessor takes responsibility for the
maintenance and security of the asset—an important
point from the user’s view. In the case of equipment,
the lessor, or owner, normally maintains a stock of
equipment in good working order that can be hired
on demand or at short notice. Th e lessor is normally
a specialist in the operation of the equipment, a fac-
tor that may be important in the case of highly spe-
cialized equipment, where the lessee may not have
the neces sary expertise or facilities to maintain the
equipment properly. Th e lessor may also undertake
to replace the equipment in the event of a serious or
prolonged breakdown. In the case of a building, the
lessor is responsible for the structural integrity of the
building, and would usually be responsible in the case
of dam age—for example, due to a natural disaster.
Th e lessor is usually also re sponsible for ensuring that
elevators, heating, and ven tilation systems function
adequately.
A4.8 Operating leases oft en aim at meeting the
needs of users who require certain types of equip-
ment only intermittently. Many operating leases are
for short periods, although the lessee may renew the
rental when the period expires and the same user may
hire the same piece of equipment on several occasions.
Be cause of the evolution of increasingly complicated
types of machinery, especially in the electronics fi eld,
the servicing and backup facilities provided by a les-
sor are important factors that may infl uence a user to
rent. Other factors that may persuade users to rent
over long periods rather than purchase are consider-
ations regarding the lessor’s balance sheet, cash fl ow,
or tax liability.
A4.9 Th e service provided under an operating lease
should be recorded as use of goods and services (22) for
the lessee and sales of goods and services (142) for the
lessor. Consumption of fi xed capital (23) on the fi xed
asset involved is recorded in the accounts of the lessor.Financial leases
A4.10 A fi nancial lease is a contract under which
the lessor, as legal owner of an asset, conveys sub-
stantially all risks and rewards of ownership of the
asset to the lessee. Th e economic nature of the ar-
rangement is such that the lessor is deemed to provide
a loan to allow the lessee to acquire the majority of
risk and re wards of ownership, but the lessor retains
legal title (ownership) as collateral for the loan. In
other words, the lessee becomes the economic owner
of the asset. Under a fi nancial lease, the lessor records
a loan to the lessee with which the lessee acquires the
asset. Th ere aft er, the leased asset is shown on the bal-
ance sheet of the lessee and not of the lessor; the cor-
responding loan is shown as an asset of the lessor and
a liability of the lessee.
A4.11 Financial leases are distinguished from
other types of leases because substantially all risks and
re wards of ownership are transferred from the legal
owner of the nonfi nancial asset (the lessor) to the user
of the nonfi nancial asset (the lessee). Th e following
provisions in the lease contract would normally lead
to a lease being classifi ed as a fi nancial lease:- Th e lease contract transfers legal ownership of the
asset to the lessee at the end of the lease term, or - Th e lease contract gives the lessee the option to
acquire legal ownership of the asset at the end of