When operating lease is really straightforward and only comprises of one linear expense on the income statement, finance lease is a bit more complicated than that and also comprises of couple of other financial statement lines being affected.

Before we can however start digging deeper into recognizing the finance lease on the balance sheet, we need to determine when we are even talking about finance lease. There are a couple of situations which usually indicate that the contract should be accounted as a finance lease (although the name of it may be ‘operating lease’). Mind you that if already one of those conditions is met, it is high chance the lease is in essence a finance lease.

Examples of those situations are as follows:
– the ownership is transferred to the lessee at the end of the lease term;
– option to buy the asset at a significantly lower price than the expected fair value of the asset at the date of the lease term;
– the lease term covers the major part of the asset’s economic life (regardless if the title is transferred or not);
– the present value of minimum lease payments amounts to significantly all of the fair value of the leased asset;
– the leased asset is specialized and so unique in nature that only the lessee can use it without any considerable modifications.

As mentioned before, those are only examples. The general rule is essentially given in the very definition of finance lease – if risks and rewards are transferred to the lessee, the agreement should be treated as finance lease. Just think through what are you getting and what risks arising are actually yours according to the agreement, and which are not. If significant part of those risks and rewards are transferred to you, it is fairly obvious you have yourself a finance lease agreement.