Finance lease

A finance lease, "financial lease" or capital lease is a type of lease in which a finance company is typically the legal owner of the asset during the duration of the lease, while the lessee not just has operating control over the asset, but also has a substantial share of the economic risks and returns from the change in the valuation of the underlying asset.

More specifically, it is a commercial arrangement where:

Finance lease is one in which risk and rewards incidental to the ownership of the leased asset are transferred to lessee but not the actual ownership. Thus in case of finance lease we can say that notional ownership is passed to the lessee. The amount paid as interest during lease period is shown in P/l DR side of lessee

Under US accounting standards, a finance (capital) lease is a lease which meets at least one of the following criteria:

Following the GAAP accounting point of view, such a lease is classified as essentially equivalent to a purchase by the lessee and is capitalized on the lessee's balance sheet. See Statement of Financial Accounting Standards No. 13 (FAS 13) for more details of classification and accounting.

The term sometimes means a special case of lease defined by Article 2A of the Uniform Commercial Code (specifically, Sec. 2A-103(1) (g)). Such a finance lease recognizes that some lessors are financial institutions or other business organizations that lease the goods in question purely as a financial accommodation and do not want to have the warranty and other entanglements that are usually associated with leases by companies that are manufacturers or merchants of such goods. Under a UCC 2A finance lease, the lessee pays the payments to the lessor (and indeed must do so, regardless of any defect in the leased goods – this obligation usually being contained in a "hell or high water" clause), but any claims related to defects in the leased goods may be brought only against the actual supplier of the goods. UCC 2A finance leases are usually easy to identify because they commonly contain a clause specifically declaring that the lease is to be considered a finance lease under UCC 2A.

In the over 100 countries that govern accounting using International Financial Reporting Standards, the controlling standard is IAS 17, "Leases". While similar in many respects to FAS 13 in the U.S., IAS 17 avoids the "bright line" tests (specifying an exact percentage as a limit) on the lease term and present value of the rents. Instead, IAS 17 has the following five tests. If any of these tests are met, the lease is considered a finance lease:

...
Wikipedia