Compare and contrast operating and finance leases.

- A finance lease is a noncancellable agreement that is, in substance, a purchase of the leased asset.

- If a lease includes one of the following requirements it is considered a capital lease:

- The ownership of the asset is transferred to the lessee at the end of the lease term.

- The lessee is allowed to purchase the asset under the lease terms at an amount that is expected to be lower than its fair market value at the time of acquisition.

- The term of the lease covers most of the economic life of the asset.

- The present value of the future minimum lease payments represents substantially all of the fair market value of the asset at the time the lease is signed.

- The asset leased is of such a specialized nature that only the lessee can use the asset without major modifications.

- If a lease qualifies as a finance lease, an asset and a liability must be recorded.

- If the lease does not meet requirements to be treated as a finance lease, then it is treated as an operating lease.

- Under an operating lease, the leased asset does not appear in the records of the lessee because the legal owner of the asset retains the risks and obligations of ownership.