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Are Finance Leases Considered Debt?

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Are Finance Leases Considered Debt? A 2025 Guide with Examples.

 Understanding Finance Leases as Debt

One of the most important questions in corporate finance and accounting today is:

Are finance leases considered debt?

The short answer: Yes. Under modern accounting standards (IFRS 16 and ASC 842), finance leases are considered debt because they represent a company’s legal obligation to make future payments over the lease term.

But why does this matter?

Understanding how finance leases are classified is critical for investors, CFOs, credit analysts, and anyone interpreting a company’s balance sheet.

In this comprehensive 2025 guide, we’ll break down:

  • What finance leases are
  • Why they’re treated as debt
  • How they differ from operating leases
  • Real-world company examples
  • Impact on financial ratios and credit ratings
  • Frequently asked questions (FAQs)

What Is a Finance Lease?

A finance lease (also known as a capital lease) is a lease agreement where the lessee (the company renting the asset) essentially assumes the risks and rewards of ownership.

Key characteristics of a finance lease:

  • Long-term in nature (covers most of the asset’s useful life)
  • Transfers ownership or gives a bargain purchase option
  • Non-cancellable
  • Lessee bears maintenance, insurance, and other costs
  • Asset is recorded on the balance sheet

Finance Lease vs Operating Lease

Note: After IFRS 16 (2019) and ASC 842 (2020), both finance and operating leases are reported on the balance sheet, but only finance leases are treated similarly to debt in financial analysis.

Are Finance Leases Considered Debt? Yes, and Here’s Why

1. Legal Obligation

A finance lease creates a contractual obligation for the lessee to pay the lease amount over a fixed term. This payment obligation is legally binding—just like taking out a loan.

2. Asset and Liability Recognition

Under both IFRS 16 and ASC 842, finance leases are treated as:

  • Right-of-use assets (asset side)
  • Lease liabilities (debt side)

This means the lease has economic substance similar to buying the asset with borrowed funds.

3. GAAP and IFRS Standards

Under IFRS 16:

“All leases, except for short-term and low-value leases, must be recorded on the balance sheet.”

Under ASC 842 (U.S. GAAP):

“Finance leases must be recognized as a right-of-use asset and lease liability, similar to debt.”

4. Credit Rating Agencies

Major agencies like Moody’s, S&P, and Fitch include finance leases as debt when calculating metrics like:

  • Debt-to-EBITDA
  • Interest Coverage Ratio
  • Fixed-Charge Coverage Ratio

They view finance leases as non-discretionary obligations just like loans or bonds.

Real-World Examples of Finance Lease Treatment

Example 1: Tesla Inc. (2024 10-K)

Tesla uses leases for gigafactory equipment and solar energy systems.

  • Tesla reports $2.5 billion in lease liabilities.
  • Classified as “finance lease obligations” in the long-term debt section.

This impacts Tesla’s leverage ratio and interest expense on its income statement.

Example 2: Apple Inc.

Apple leases retail stores and equipment under long-term contracts.

  • Reported over $9 billion in lease liabilities in 2024.
  • The finance lease portion increases Apple’s total liabilities and reduces return on assets (ROA).

This impacts how analysts and investors value the company.

How Finance Leases Affect Financial Statements

This shift in classification can improve operating cash flow but increase reported debt.

Finance Lease as Debt: Impact on Financial Ratios

1. Debt-to-Equity Ratio

Since lease liabilities count as debt:

  • Increases total liabilities
  • Raises leverage ratio
  • May affect loan covenants and investor perception

2. EBITDA and EBIT

EBITDA may appear stronger, since lease payments are now split into:

  • Interest (below EBITDA)
  • Depreciation (non-cash)

But investors must adjust for this when comparing across firms.

3. Return on Assets (ROA)

Since total assets increase, ROA usually declines, even if net income remains unchanged.

Why Classifying Finance Leases as Debt Matters

For Investors:

You get a clearer picture of the company’s obligations and financial health.

For Lenders:

Finance lease liabilities can affect debt covenants and creditworthiness.

For Companies:

Recognizing finance leases as debt can impact:

  • Loan approvals
  • Bond ratings
  • Equity valuations

Strategic tip: Many firms negotiate “off-balance-sheet” structures to lower their reported debt, but updated standards minimize these tactics.

FAQs: People Also Ask

Is a finance lease a debt or equity?

A finance lease is debt. It represents a fixed obligation and appears as a liability on the balance sheet.

Are finance leases included in total debt?

Yes. Under both IFRS 16 and ASC 842, finance lease liabilities are included in total debt by analysts, credit agencies, and regulators.

How are finance leases recorded?

They are recorded with:

  • A Right-of-use asset
  • A Lease liability (present value of future payments)

Do finance leases affect credit rating?

Yes. Since finance leases increase total liabilities, they can negatively impact credit ratings, especially for companies with high lease obligations.

Are finance leases tax-deductible?

In most jurisdictions, interest on finance leases and depreciation of leased assets are tax-deductible. Always check local tax laws.

How to Identify Finance Leases in Financial Reports

Look in the Notes to the Financial Statements or MD&A section. Most public companies disclose:

  • Total lease liabilities
  • Breakdown into operating and finance leases
  • Maturity schedules
  • Discount rate assumptions

Tip: Use EDGAR for U.S. SEC filings or company investor relations pages.

Advantages of Finance Leases (Despite Being Debt)

Even though they count as debt, finance leases offer benefits:

When Is a Lease Classified as a Finance Lease?

Use the 5 Tests under ASC 842/IFRS 16:

  • Ownership transfers at the end?
  • Bargain purchase option?
  • Lease term covers majority of useful life?
  • Present value of payments ≈ asset’s fair value?
  • Asset is specialized and only useful to lessee?

If any one is true → Finance Lease.
If none are true → Operating Lease.

Best Practices for Companies Managing Lease Debt

1. Perform Lease vs Buy Analysis

Weigh the total cost, tax impact, and accounting treatment before choosing to lease.

2. Disclose Clearly to Investors

Transparent disclosure helps avoid misunderstandings and improves credit evaluation.

3. Monitor Covenants and Leverage

Some debt covenants exclude lease liabilities; some don’t. Track both reported and adjusted debt metrics.

4. Consider Sale-Leaseback

This lets firms sell an asset and lease it back—raising cash while maintaining asset use. However, the leaseback becomes a liability.

Expert Opinion: Are Finance Leases “Bad Debt”?

Not necessarily. Finance leases are strategic tools, not inherently bad debt.

They’re often used for:

  • Aircraft, heavy machinery, vehicles
  • High-tech equipment
  • Large-scale manufacturing assets

But because they are counted as debt, they must be used wisely and transparently.

Conclusion: Yes, Finance Leases Are Considered Debt

To summarize:

  • Finance leases are treated as debt obligations on financial statements.
  • They increase liabilities, affect credit ratings, and impact financial ratios.
  • Real-world companies like Tesla and Apple disclose billions in finance lease liabilities.
  • Updated standards (IFRS 16 and ASC 842) have made lease accounting more transparent for investors and analysts.

Bottom Line:
If you analyze companies, seek funding, or manage financial statements—treat finance leases as debt. Understanding their impact is essential for sound financial decisions in 2025 and beyond.