CA Intermediate · Financial Management and Strategic Management · Types of Financing
A company obtains a machine under a financing arrangement in which the lessor retains legal ownership, the company pays fixed periodic rentals for the asset's economic life, and the lessee is responsible for maintenance and insurance. Which type of financing does this best describe?
This is a finance lease. The lease runs for most of the asset's economic life and the lessee bears maintenance and insurance, so risks and rewards of ownership pass to the lessee, even though legal title stays with the lessor. An operating lease would be shorter, with the lessor bearing such costs.
- AFinance leaseCorrect
- BOperating lease
- CVenture capital financing
- DFactoring without recourse
Explanation
Where the lease covers substantially the whole economic life of the asset and the lessee bears maintenance and insurance, the arrangement is a finance lease. An operating lease is for a shorter period, with the lessor usually bearing these costs, so it does not fit.
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