Operating lease

An operating lease is a contract that gives the lessee the right to use an asset without acquiring ownership of it. It is essentially a rental arrangement: the lessee uses the equipment, vehicle, or office space for a portion of its life, then returns it to the lessor, who retains the risks and rewards of ownership, including residual value.

Lease classification turns on whether the arrangement is in substance a purchase. A lease is a finance lease if it meets criteria such as transferring ownership at the end of the term, containing a purchase option the lessee is reasonably certain to exercise, covering the major part of the asset's economic life, or having payments whose present value equals substantially all of the asset's fair value. A lease that meets none of these criteria is an operating lease.

Under current U.S. GAAP (ASC 842), lessees put operating leases on the balance sheet, recording a right-of-use asset and a lease liability for leases longer than 12 months. The income statement treatment still differs from a finance lease: an operating lease produces a single, straight-line lease expense each period, while a finance lease is split into amortization of the asset and interest on the liability, which front-loads total expense.

The CMA Part 1 exam tests lease classification and accounting directly. Be ready to apply the finance-lease criteria, conclude that a failing lease is an operating lease, and produce the correct expense pattern — straight-line for operating leases versus amortization plus interest for finance leases.