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

A manufacturing company obtains machinery on a finance lease. In which of the following respects does a finance lease differ from an operating lease, from the lessee's financing point of view?

A finance lease typically runs for substantially the whole economic life of the asset and is non-cancellable, so the lessee bears the risks and rewards of ownership. Easy cancellation and lessor-borne obsolescence risk are characteristics of operating leases, not finance leases.

  1. AThe lessor bears the risk of obsolescence and the lease is easily cancellable
  2. BThe lease covers substantially the whole economic life of the asset and is generally non-cancellableCorrect
  3. CThe lessee has no obligation to pay rentals if the asset is not used
  4. DThe lessor is responsible for maintenance and insurance of the asset in every case

Explanation

A finance lease is a long-term, non-cancellable arrangement covering most of the asset's economic life, and the lessee effectively bears the risks and rewards of ownership. Cancellability and lessor-borne obsolescence risk are features of an operating lease, so the first option is wrong.

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