FAR-AMT Practice Test

Under ASC 842, the key test for a lessee is whether the lease transfers substantially all the risks and rewards of ownership of the asset. If that transfer occurs, the arrangement is a finance lease, and the lessee records a right-of-use asset and a lease liability, then depreciates the asset and recognizes interest on the liability over the lease term. This criterion directly captures the economic effect of the lease—the lessee effectively owns the asset for most of its life despite not having legal title.

The other descriptions describe situations that would not constitute a finance lease. For example, a situation where the lessee bears only incidental risks and rewards points to an operating lease, where the payment is treated as a lease cost rather than a financed asset and liability. The notion of the term being longer than the asset’s useful life or guaranteeing residual value does not by itself define a finance lease under ASC 842.

So the best answer is the one that states the transfer of substantially all risks and rewards of ownership, since that encapsulates the core criterion used to classify a lessee’s lease under ASC 842.