Q. Off balance sheet financing?

A finance charter exists when the substance of the lease is that the lessee enjoys substantially all of the risks and rewards of ownership even though legal title to the leased asset doesn't pass from lessor to lessee. A finance lease is thus characterised by one lessee for most if not all of its useful economic life with the lessee meeting maintenance and similar regular costs.

A finance lease can't be cancelled once entered into without incurring severe financial penalties. A finance lease thus acts as a kind of medium-to long-term source of debt finance which in substance permits the lessee to purchase the desired asset. This ownership dimension is documented in the statement of financial position where a finance-leased asset should be capitalised as a fixed asset mutually with the amount of the obligations to make lease payments in future periods (as a liability).

In compare an operating lease is a rental agreement where several lessees are expected to use the leased asset and therefore the lease period is much shorter than the asset's useful economic life.

Maintenance and comparable costs are borne by the lessor with this cost being reflected in the lease rentals charged. An operating lease is able to usually be cancelled without penalty at short notice. This permits the lessee to ensure that only up-to-date assets are leased for use in business operations avoid the obsolescence problem associated with the rapid pace of technological change in assets such as personal computers and photocopiers. For the reason that the substance of an operating lease is that of a short-term rental agreement operating leases don't require to be capitalised in the statement of financial position allowing companies to take advantage of this form of "off balance sheet financing.