What is the difference between operating leasing and financial leasing?
Operating and financial leasing are frequently confused, as the differences between them are not always immediately clear. The structure during the contract period can often appear similar. But how do you determine whether an agreement should be accounted for as operating or financial leasing? In this article, we explain how the two leasing models are structured, what truly sets them apart, and how to determine the correct accounting classification for your specific lease agreement.
Operating and financial leasing are often confused, as the structure during the contract period in many cases looks almost identical. In practice, both models are based on the same fundamental principles and the same five components (price, contract term, interest rate, fee, and residual value). However, despite these similarities, there are important differences. Let’s take an example:
Price: SEK 250,000
Contract term: 36 months
Interest rate: 5%
Fee: SEK 4,000 per month
Residual value: SEK 30,000
Regardless of whether the lease is classified as operating or financial, these five components are always included. The structure is fundamentally the same: the finance company purchases the asset, leases it to the customer for a fixed period in exchange for a set fee and interest rate, and calculates a residual value. If you know four of the five components, the fifth can always be calculated.
What distinguishes the two types of leasing is what happens at the end of the lease term and who bears the responsibility for the residual value.
What is operating leasing?
Operating leasing can be described as a form of rental where the finance company bears the residual value risk.
This means that:
The customer leases the asset for an agreed term, for example 36 months, and pays a monthly fee, for example SEK 4,000 per month.
The residual value is the responsibility of the finance company.
When the agreement expires, the asset, for example a car, is returned, and the customer can usually choose to enter into a new agreement.
For the customer, the interest rate, residual value, and purchase price of the asset are typically not relevant, as these elements are already reflected in the lease payment. The finance company bears the financial risk related to the asset’s future value.
What is financial leasing?
Financial leasing can, in practice, be compared to a financed purchase. During the lease term, the structure is largely the same as in an operating lease: the customer pays a fixed fee and uses the asset in the same way. The difference arises at the end of the agreement and can be summarised as follows:
When the lease term ends, the customer is required to settle the residual value, either by paying it themselves or by selling the asset.
If the asset is sold for more than the residual value, a profit arises; if it is sold for less, a loss is incurred.
In other words, the customer bears the financial risk as well as the potential upside at the end of the agreement.
The customer therefore bears both the financial risk and the potential benefit associated with the asset’s future value. From an accounting perspective, this is crucial, as it is the allocation of financial risk that determines how the agreement is classified and accounted for.
Summary
Both operating and financial leasing consist of the same five core components and function in the same way during the lease term. The key difference lies in the residual value.
In an operating lease, the asset is returned at the end of the term, and the customer has no responsibility for the residual value.
In a financial lease, the customer bears the responsibility for the residual value.
It is the clause in the agreement that regulates what happens at the end of the lease term that ultimately determines which type of leasing arrangement it is.