Finance Lease is the purchase of some asset by the buyer (lessee) that is directly financed by the seller (lessor). It is similar to purchasing the asset.
An Operating Lease is an agreement which lessee to use the asset for a period of time. It is similar to renting an asset.
Classification of Lease:
Under IFRS, if substantially all risks and rewards related to ownership are transferred to the lessee, the lease is classified as a finance lease and a lessee reports a leased asset and a lease liability on the balance sheet.
Under U.S. GAAP, a lease that meets any one of four specific requirements is classified as a finance lease.
The four requirements are as follows:
1) Ownership of the leased asset transfers to lessee at end of lease.
2) The lease contains an option for the lessee to purchase the leased asset at a price less than fair market value of the asset at some future date (also known as bargain purchase option).
3) The lease term is 75% or more of the useful life of the leased asset.
4) The PV of lease payments is 90% or more of the fair value of the leased asset.
NOTE: A lease which does not meet any of these criteria is classified as an operating lease
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