## Finance Lease vs Operating Lease (AS-19)
When auditing entities that use leased assets, the auditor must understand how each type of lease is classified and treated — since misclassification distorts the Balance Sheet.
### Classification Under AS-19
A lease is classified as a Finance Lease if it substantially transfers all risks and rewards of ownership. Indicators include:
- Lease term covers a major part of the economic life of the asset.
- Lessee bears insurance, maintenance, and other ownership-type costs.
- Ownership transfer option exists at end of lease.
All other leases are Operating Leases.
### Comparison: Lessee's Perspective
| Dimension | Finance Lease | Operating Lease |
|---|---|---|
| Analogy | Like a loan (hire purchase) | Like renting |
| Asset on Balance Sheet | Yes — appears as lessee's asset | No — off-balance sheet |
| Ownership | With lessee (economic ownership); legal title may remain with lessor | With lessor |
| Lease payment treatment | Split into principal repayment + interest expense | Treated as operating expense |
| Depreciation | Lessee claims depreciation | Lessee cannot claim depreciation |
| Tax benefit | Both interest + depreciation deductible | Only lease payment deductible (like rent) |
### Audit Implications
- Verify the lease agreement to determine correct classification.
- For finance leases: check that asset and corresponding liability are recognised on the Balance Sheet at lower of fair value or present value of minimum lease payments.
- For operating leases: confirm lease rentals are expensed in the correct period.