What is a Finance Lease?
Also referred to as a capital lease or sales lease, a finance lease is a form of a commercial lease in which a global finance company is the legal owner of the financed asset, with the user leasing the asset for a contractual amount of agreed-upon time. In the official finance lease agreement, the leasing agent is referred to as the lessor, and the user of the asset is referred to as the lessee.
When entering into the lease agreement, the lessee retains operating control over the asset. The user assumes all responsibility for any rewards or risks associated with the ownership of the asset. This legal lease contract provides the lessee with financial information of ownership for the leased asset. The lessee records the asset as a fixed asset, as well as the interest of the lease payment as an expense.
How Does a Lease Finance Work?
- The lessee selects the asset they require for their business.
- The lessor then purchases the asset.
- The lessor and lessee enter into a legal leasing contract in which the lessee will have use of the asset during the agreed-upon time period.
- The lessee makes a set amount of payments for the use of the asset.
- The lessor recovers the cost of the asset plus interest.
- At the end of the lease contract, the lessee has the option to purchase the asset.
A financial lease can have a big impact on the financial statements of the company. For accounting purposes, a financial lease is viewed as ownership as opposed to a rental, thereby influencing assets, liabilities, depreciation expenses, and interest expenses.
What Qualifies as a Finance Lease?
Finance leases are used in a wide variety of industries. They are mainly used when a company needs an expensive piece of equipment but wants to bypass paying a large lump sum of money out of pocket or needs to preserve its cash flow.
Some equipment commonly acquired through finance leasing include:
- Heavy machinery
- Diesel engines
- Plant equipment
Depending on the asset to be leased, the finance lease will be tailored to suit the specific needs of the lessor and lessee. The agreement will be reached based on the price of the asset being leased and the terms of the agreement.