Financial lease is where all the lease payments total up to the fair value of the asset, and at the end of the lease term, the ownership gets transferred to the lessee.
However, when you come across a lease straightlining done by the company for a lease, during audit, how should you identify whether it is a Financial lease or an Operating lease?
What are the indicators for that?
As per AS - 19, whether a lease is a finance or operating lease, it depends on the substance of the transaction rather than its form. Some of the following indicators for financial lease are -
1) The lessee has the option to purchase the asset at the price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable.
2) The lease term is for the major part of the economic life of the asset, even if the title is not transferred.
3) The leased asset is of a specialised nature such that the lessee can use it without any major modifications being made.
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