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CA Intermediate · Financial Management and Strategic Management · Types of Financing

A company arranges its machinery purchase through a lease in which the lessor retains ownership throughout, the lessee pays periodic rentals, and the lessee has no option to buy and the lease is cancellable on short notice, with the lessor bearing maintenance and insurance. Which type of lease is this?

This is an operating lease. The lessor keeps ownership, the lease can be cancelled at short notice, there is no purchase option, and the lessor bears maintenance and insurance. A finance lease would be non-cancellable and would transfer substantially all risks and rewards to the lessee.

  1. AFinance lease
  2. BOperating leaseCorrect
  3. CSale and leaseback
  4. DLeveraged lease

Explanation

An operating lease is short-term and cancellable, with no transfer of ownership, and the lessor usually bears maintenance and insurance. A finance lease is non-cancellable and covers substantially the whole economic life of the asset, with the lessee bearing the risks. Sale and leaseback requires the lessee to have sold the asset to the lessor first.

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