A service Lease is a type of lease where the lessor undertakes the responsibility to serve all the assets leased out by the lessee.
An operating Lease is considered 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 that it requires the lessor to maintain and service the underlying asset, even though the lessee is using the asset, and holds possession of the leased asset.
The main reason behind this is that a service lease is normally tied with the leasing of equipment that is normally for a shorter period, and the lease payments 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 in cost. They are mostly day-to-day items that are required for operations in a company.
Hence, a 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 recurring. They normally don’t constitute relevant to the company’s main operations.
Features of Service Lease?
A service Lease is very common, just like an operating lease. They have the following salient features:
- Ownership of the asset stays with the lessor: During the lease term, the asset’s possession is with the asset’s user. 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 an operating cost; therefore, this cost is incurred in the Income Statement as an Operating Cost. The company does not capitalize on this cost.
- The lessor undertakes depreciation of the Asset: Given that the lessor takes back possession of the asset once the lease term ends, it makes sense for the lessor to depreciate the asset in his 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 on the Balance Sheet.
- Maintenance and service of the asset is the lessor’s responsibility: Under the service lease, the lessor undertakes the responsibility of ensuring that the asset is in running and functioning condition. Therefore, it is imperative to consider that these assets need to be utilized for a better outcome in the long run.
- Service Lease is often utilized for assets that are not that expensive.
Service Lease vs Financial Lease and Operating Lease
During the normal course of the business, several different leasing options are available depending on the type of asset the company requires.
Between service lease, operating lease, and financial lease, it can be seen that all these different lease types target different sorts of functionalities.
Service lease is mostly procured by individuals that require maintenance-free assets, to be utilized during the company’s operations.
Companies who opt for service leases mostly do not purchase back these assets at the end of the lease term.
On the other hand, an 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 an operating lease is often rendered by organizations that require excess capacity, or some machinery for a limited period.
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 a financial lease (also referred to as a capital lease) is concerned, it can be seen that a financial lease is often used by companies that are looking to arrange for Non-Current Assets but lack the resources to procure them upfront.
As a result, they get into a financial lease agreement which gives 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. Therefore, assets that are leased under this lease type are considered to be significant.