You want to have a photocopier and you have two choices:

  1. you can buy it and then you become the owner of the photocopier;
  2. you can lease it from the lessor and then you would become the lessee.


IAS 17 leases describes two types (forms) of leases:

*Finance lease: lease that transfers the risks and rewards of the asset from the lessor to the lessee.

*Operating lease: any leases other than finance lease.


5 senarios

So the substance over form concept behind it can be summarized as follows:

IAS 17 prescribes there are 5 common scenarios that the lease is a finance lese. (one of them fulfilled then it’s a finance lease and if none of them fulfills then it’s an operating lease.)

  1. ownership of asset has been transferred from lessor to lessee.
  2. lessee has the option to purchase asset at a price which is sufficiently lower than its FV.
  3. lease term is almost the same as the major part of economic life of asset.
  4. (IFRS doesn’t specify the period but US GAAP has given us guidance of >75%.)

  5. at the start of the lease, PV of minimum lease payment is close to FV of asset.
  6. (again, IFRS doesn’t specify the percentage but US GAAP has given us a guidance of >90%.)

  7. leased assets are specified nature and can only be used by lessee and they can be used by others if any significant modification to assets occurs.


Risks and rewards

But the idea behind it is when the majority risks and rewards has been transferred from the lessor to lessee then it’s considered to be a finance lease.

So the typical risks and rewards may include:


  • costs of repairing, maintaining and insuring the assets.
  • Risk of obsolescence
  • Risks of losses from idle capacity of the asset (if machine breaks down then lessee bears the loss)


  • Use of assets for almost all of its useful life.
  • Use of the assets is not disrupted.


Accounting Treatment:


  Lessee(F7) Lessor(P2)
Finance lease:
Initial measurement DR PPECR lease liability DR lease receivableCR lease asset
Subsequent measurement PPE: DR I/S-depre expense

CR accumulated depreciation


Lease liability:

DR lease liability

DR I/S-finance cost

CR cash






DR cash (from lessee)

CR lease receivable

CR I/S-interest income

Operating lease:
Expense the lease payment on a straight line basis 


CR cash

Expense the lease revenue received on a straight line basisDR cash


Keep the assets in FS and depreciates it.

DR I/S-depreciation expense

CR accumulated depreciation