ACCA Financial Reporting (F7) Practice Exam

What distinguishes a finance lease from an operating lease for the lessor?

1. A finance lease transfers substantially all risks and rewards of ownership

2. Operating leases are not recorded on the balance sheet

3. A finance lease typically has a shorter duration

4. All lease types are treated the same

The correct answer is: A finance lease transfers substantially all risks and rewards of ownership

A finance lease is characterized by the transfer of substantially all risks and rewards associated with ownership of the underlying asset from the lessor to the lessee. This means that, although the lessor retains legal title to the asset, the lessee assumes most of the economic benefits and obligations of ownership. For the lessor, recognizing a lease as a finance lease has significant implications for financial reporting, as it allows the lessor to record the asset and the corresponding long-term receivable on its balance sheet. In contrast, an operating lease does not transfer significant risks and rewards of ownership to the lessee. The lessor typically continues to recognize the asset on its balance sheet and accounts for rental income over the lease term, treating it more like a short-term rental arrangement. Understanding this distinction is crucial because it affects how leases are recorded and reported in financial statements, influencing both the lessor’s and lessee's financial positions and performance indicators. The other choices do not accurately capture the foundational difference between finance and operating leases for lessors. Operating leases being off-balance-sheet is not universally applicable to finance leases; finance leases are specifically designed to be characterized by the transfer of risks and rewards. Similarly, finance leases often have longer durations and are not treated