Understanding Finance Lease: Definition, Characteristics, and Accounting Impact

This article explains the concept of finance lease, its definition, characteristics, and accounting impact. It discusses how finance lease works, its benefits, and how it affects the balance sheet and cash flow. It also highlights the differences between financial lease and operating lease, and the impact of IFRS 16 on financial lease. The article cites relevant studies and references to support the discussion.

FINANCE LEASE

Introduction
The financial lease or the capital lease is the lease where the financial company is
generally the legal owner for certain assets for a particular time duration. The lessee is not only
the person who is controlling all the assets. The substantial forms are related to handle the
different risks and the returns which includes handling of the underlying assets that are related to
settle with proper valuation factors. (Qin et al., 2017). The commercial arrangement is where the
lessee will be selected as an asset, and the lessor will be able to purchase that asset. There are
payments for handling the installments which are considered important and are generally used as
an asset. The lessor will also be able to recover the larger part or the costs of the assets along
with the interest that is earned from the rentals which have been paid by the lessee.
Finance Lease
The financial lease has different characteristics for hiring a purchase agreement and
closed end leasing comes with usual outcomes. There might be certain benefits for the taxes for
the lessee to lease an asset rather than purchasing it or motivating it for obtaining a financial
lease. The impact on accounting is when financial lease is capitalized with assets and liabilities
and there is an increase of the same in the balance sheet as well (Bohušová, 2015). The working
capital, thereby, decreases with the increase in the debt or equity ratio. The financial lease
expenses are then allocated mainly in between the expense generated for the interest and the
principal value like for the bond or the loan. There are statements related to handle the cash flow
and then there are parts set for the lease payments which are seen to be reported under the proper
operating cash flow which is considered to be a part of the financing cash flow. The operating
cash flow tend to increase, henceforth. As per the analysis, it is seen that there are certain
conditions which are related to handle the operations for the lease, where there are certain
obligations set for the lease statements. They are not recognized till the time there are certain
ratios which are set for it. There are certain ratios which are understated and holds the return on
the ratios which are found to be overstated. Hence, as per IFRS, there is a need to work on the
different risks and the rewards which are important for the working over the lessee and handling
the ownership factors. This is considered important for working on the financial lease. There has
to be an operating lease, if there is no financial lease, which is able to handle the risks transfer to
the lessee (Hao, 2015). This is mainly in the terms of how lessee works with the options to buy

the assets at a lower pricing with holding the residual value at the end. The nature of the asset is
about working with the length of lease terms which covers the present value of the payments and
the other asset cost factors. The possibilities are mainly to make use of the balance sheets to look
for a better and justified treatment for operating the leases (Minhat & Dzolkarnaini, 2016). The
classification is done through the sales and the leaseback of property which might have a major
impact on the accountancy and the measures related to the gearing process. The improvement of
the financial gearing might be considered as an offset with worsening of the operational gearing
patterns.
It has been seen that IFRS with controlling IAS 17 standards are being currently phased
out and being replaced with IFRS 16. There are financial lease where the asset ownership is then
transferred to the lessee and then there are lease terms which are for bargained purchase options.
The lease terms are for the economic life of the asset which is not transferred. in Australia,
AASB 117 Leases are recommended which applied to the terms of accounting other than the
leases which are for exploring the use of the minerals, oil and the natural gas along with other
resources. AASB 117, p4, highlights about how the agreement is made where the lessor also
conveys to work with returns for payments or the series of it for the right to make use of an asset
for a particular amount of time. The financial lease is effectively able to work on buying the
assets for the user and then renting it for a particular period (Wong & Joshi, 2015). This is when
the lessor retains the ownership of the asset with lessee getting exclusive use for the assets. It is
mainly at the time of initial or the primary period of lease. The customer is also committed to
pay the rentals with technically understanding the financial lease that is considered to be non-
cancellable although it tends to terminate early. The financial lease is the method for handling
financial assets where they are still the property of the financial company only for hiring and
lessee pays for hiring asset or assets (Ionascu & Ionascu, 2018).
Conclusion
The financial lease agreements are effective as they help in setting the regular payments
with minimizing the cost upfront as well. The rentals are usually Corporation Tax deductible
with the potential to carry on through using the assets mainly at the end of the leasing period.
There are additional line of finance which might not affect the banking arrangements which is
considered to be a major benefit of finance lease.

References
Bohušová, H., 2015. Is Capitalization of Operating Lease Way to Increase of Comparability of
Financial Statements Prepared in Accordance with IFRS and US GAAP?. Acta Universitatis
Agriculturae et Silviculturae Mendelianae Brunensis, 63(2), pp.507-514.
Hao, Z., 2015. The occurrence mechanism and avoidance of risk in medical equipment finance
lease.
Ionascu, I. and Ionascu, M., 2018. Business Models for Circular Economy and Sustainable
Development: The Case of Lease Transactions. Amfiteatru Econ, 20, pp.356-372.
Minhat, M. and Dzolkarnaini, N., 2016. Is executive compensation a substitute governance
mechanism to debt financing and leasing?. Applied Economics, 48(14), pp.1293-1302.
Qin, Q., Liang, F., Li, L. and Wei, Y.M., 2017. Selection of energy performance contracting
business models: A behavioral decision-making approach. Renewable and Sustainable Energy
Reviews, 72, pp.422-433.
Wong, K. and Joshi, M., 2015. The impact of lease capitalisation on financial statements and key
ratios: Evidence from Australia. Australasian Accounting, Business and Finance Journal, 9(3),
pp.27-44.