Finance Lease

In a finance lease, the lessee uses the asset for most or all of its useful life and effectively bears the costs and benefits of ownership, even though the lessor may keep legal title.

Signs of a finance lease include the lease term covering most of the asset's life, the lessee being able to buy the asset at a bargain price at the end, ownership transferring automatically, or lease payments that add up to nearly the full value of the asset.

For example, a company leases a machine for eight years when its useful life is nine years, with the option to buy it for a small sum at the end. That arrangement is likely to be a finance lease.

The lessee records the asset and a lease liability on its balance sheet. Over time, it depreciates the asset and records interest on the liability, so the income statement shows depreciation and interest rather than a single rent expense.

Under IFRS 16, lessees account for nearly all leases this way, regardless of classification. Under US GAAP, the finance lease classification remains and determines how costs are presented.