What is a primary difference between finance leases and operating leases?

The primary difference between finance leases and operating leases lies in the transfer of risks and rewards associated with ownership of the leased asset. In an operating lease, the lease agreement typically does not transfer the significant risks and rewards of ownership to the lessee. This means that under an operating lease, the lessee has the right to use the asset for a specified period, but they do not assume the risks associated with asset ownership, such as maintenance costs or residual value risk. The lessor remains the owner of the asset and retains these risks and rewards.

On the other hand, finance leases transfer substantially all the risks and rewards of ownership to the lessee. In this case, the lessee effectively uses the leased asset as if they own it, which is why finance leases are typically treated as asset purchases in accounting. The asset is recognized on the balance sheet of the lessee, and the lease payments are considered a liability.

The other choices do not accurately capture the distinction. Recognizing assets is a characteristic of finance leases, but operating leases also involve asset recognition in certain contexts, such as in the context of IFRS 16, which requires the lessee to recognize operating leases on the balance sheet under certain conditions. The notion of ownership transfer is commonly