Final answer:
For it to be a finance lease, it has to pass one or more of these tests.
Step-by-step explanation:
In accounting and finance, a finance lease is distinguished from an operating lease based on certain criteria set out by accounting standards like the International Financial Reporting Standards (IFRS) or the Generally Accepted Accounting Principles (GAAP).
The tests typically include whether ownership is transferred by the end of the lease term, if there is an option to purchase the asset at a price expected to be sufficiently lower than the fair value at the date the option becomes exercisable, if the lease term covers a majority of the asset's economic life, or if the present value of the minimum lease payments amounts to substantially all of the fair value of the leased asset.
It is important to correctly classify a lease as either operating or financing due to the differing impact on a company's financial statements. A finance lease recognizes an asset and a liability on the balance sheet, affecting both the income statement in terms of depreciation and interest, as well as ratios pertinent to indebtedness and asset management.