What is a Finance Lease?

A finance lease (also known as a capital lease or a sales lease) is a type of lease in which a finance company is typically the legal owner of the asset for the duration of the lease, while the lessee not only has operating control over the asset, but also some share of the economic risks and returns from the change in the valuation of the underlying asset.

More specifically, it is a commercial arrangement where:

• the lessee (customer or borrower) will select an asset (equipment, software);
• the lessor (finance company) will purchase that asset;
• the lessee will have use of that asset during the lease;
• the lessee will pay a series of rentals or installments for the use of that asset;
• the lessor will recover a large part or all of the cost of the asset plus earn interest from the rentals paid by the lessee;
• the lessee has the option to acquire ownership of the asset (e.g. paying the last rental, or bargain option purchase price);

Under each standard, a lease must be classified.  Under ASC 842, the options are finance & operating.  Under IFRS 16, finance is the only option for lessees. 

Different classifications will produce different amortization schedules and different line items in a disclosure report.