Service Lease is a type of lease where the lessor undertakes the responsibility to service all the assets that are leased out by the lessee.
Operating Lease is considered to be a primitive example of a service lease, where the lessor undertakes the responsibility of providing maintenance to the lessee.
The main distinguishing factor when it comes to service lease is the fact that service lease requires the lessor to maintain and service the underlying asset, despite the fact that the lessee is using the asset, and holds possession of the leased asset.
The main reason behind this is the fact that service lease is normally tied with leasing of equipment that is normally for a shorter time period, and the lease payments that are made to the lessor are also not substantial enough to cover a significant portion of the cost of the asset.
Service lease is mostly rendered in cases where companies procure assets that are not that substantial or significant in cost. They are mostly day to day items that are required for operations in a company.
Hence, service lease is mainly utilized in cases where the equipment that is under scrutiny by the company is utilized for goods and services that are used in recurring. They normally don’t constitute to be relevant to the main operations of the company.
Features of Service Lease?
Service Lease is very common, just like operating lease. They have the following salient features:
- Ownership of the asset stays with the lessor: During the lease term, the possession of the asset is with the user of the asset. However, once the lease period ends, the asset is transferred back to the lessor.
- Lease Cost as an Expense in the Income Statement: Service Lease is considered to be an operating cost, and therefore, this cost is incurred in the Income Statement as an Operating Cost. This cost is not capitalized by the company.
- Depreciation of the Asset is undertaken by the lessor: Given the fact that the lessor takes back the possession of the asset once the lease term ends, it makes sense for the lessor to depreciate the asset in his own books. Where on one hand, the lessee treats the lease payments as an expense in the Income Statement, it can be seen that the lessor is supposed to treat this as a Non-Current Asset in the Balance Sheet.
- Maintenance and service of the asset is the responsibility of the lessor: Under the service lease, the lessor undertakes the responsibility of making sure that the asset is in the running and the functioning condition. Therefore, it is imperative to consider the fact that these assets need to be utilized for a better outcome in the longer run.
- Service Lease is often utilized for assets that are not that expensive.
Service Lease vs Financial Lease and Operating Lease
During normal course of the business, there are several different leasing options that are available depending on the type of asset that is required by the company.
Between service lease, operating lease, and financial lease, it can be seen that all these different lease types target different sort of functionalities.
Service lease is mostly procured by individuals that require maintenance free assets, to be utilized during the operations of the company. Companies who opt for service lease mostly do not purchase back these assets at the end of the lease term.
On the other hand, operating lease may also include covenants that shift the burden on the lessor to maintain and service the asset.
However, it can be seen that operating lease is often rendered by organizations that require excess capacity, or some machinery for a limited period of time.
They do not intend to purchase the asset at the end of the lease term, and therefore, they do not want to incur any major repair or maintenance charges that might be incurred on the asset.
Lastly, as far as financial lease (also referred to as capital lease) is concerned, it can be seen that financial lease is often used by companies that are looking to arrange for Non-Current Assets, but they lack the resources to procure them upfront.
As a result, they get into a financial lease agreement which given them a bargain purchase option at the end of the lease period.
This is mainly rendered by companies when they need to undertake bigger projects, and therefore, assets that are leased under this lease type are considered to be significant and substantial in nature.