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

A company obtains machinery on a finance lease and pays fixed annual rentals, with ownership usually passing to it or the asset being used for most of its life. Which feature best distinguishes this finance lease from an operating lease in the Financial Management context?

A finance lease is one where the lessee bears substantially all the risks and rewards incidental to ownership of the asset. The lease usually runs for most of the asset's economic life and is non-cancellable, unlike an operating lease where the lessor retains these risks and rewards.

  1. AThe lessor bears most risks and rewards of ownership
  2. BThe lessee bears substantially all risks and rewards incidental to ownershipCorrect
  3. CThe lease is always cancellable at short notice by the lessee
  4. DThe lessee never records the asset in its books

Explanation

In a finance lease the lease term covers most of the asset's economic life and the lessee bears substantially all risks and rewards of ownership. The first option describes an operating lease, where the lessor retains them. Finance leases are generally non-cancellable.

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