A finance lease, also referred to as a capital lease or sales lease, is a type of commercial lease in which a finance company is the legal owner of an asset, and the user rents the asset for an agreed-upon period of time. In this legal contract, the leasing company, usually the finance company, is called the lessor, and the user of the asset is called the lessee.

When a lessee enters into this agreement, they have operating control over the asset. They take responsibility for all the risks and rewards associated with the ownership of the asset. For accounting purposes, the lease provides the lessee with economic characters of ownership of the asset.

The lessee will record the asset as a fixed asset in their general ledger. In this situation, the lessee will record the interest of the lease payment as an expense.

To be classified as a finance lease under US GAAP, the rental contract must meet at least one of the following requirements:

• The present value of the lease rentals is equal to or greater than the fair market value of the asset
• The lease term is more than 75% of the leased asset’s useful life
• The option to purchase the leased asset at a lower price than the fair value of the leased asset is given to the lessee.
• The legal ownership of the leased asset transfers from the lessor to the lessee at the end of the lease.

In an IFRS jurisdiction, however, a lease is classified as a finance lease if all of the following basic criteria are met:

• Throughout the duration of the lease period, the lessor remains the legal owner of the asset
• The risk and rewards related to leased assets are transferred to the lessee
• Legal ownership of leased asset transfers from the lessor to the lessee after the end of the lease.