Questions:
What is the difference between an operating lease and a financial lease?

Rafay is a lessor and is drawing up a lease agreement for a building.
The building has a remaining useful life of 50 years. The lease term, which would commence on 1 January 2020, is for 30 years.
Rafay will receive 40% of the asset's value upfront from the lessee, and at the end of each of the 30 years, Rafay will receive 6% of the asset's fair value as of 1 January 2020.
The Legal title at the end of the lease remains with Rafay, but the lessee can continue to lease the asset indefinitely at a rental that is substantially below its market value. If the lessee cancels the lease, it must make a payment to Rafay to recover its remaining investment.

In above scenario should the lease be classified as an operating lease or a finance lease?

Reference answers:
Operating Lease:
- The lessee uses the asset for a specific period, usually less than the asset's economic life.
- The lessor retains ownership and risks.
- Lease payments are expensed as operating expenses.
- No asset or liability is recorded on the lessee's balance sheet.

Finance Lease:
- The lessee uses the asset for a significant part of its economic life.
- The lessee bears the risks and rewards of ownership.
- Lease payments are split into interest and principal, like loan repayments.
- The asset and corresponding liability are recorded on the lessee's balance sheet.

This is a financial lease.

In general, operating leases are for shorter periods and more like rentals, while finance leases are longer-term and more like financing agreements. IFRS 16 has introduced new criteria to classify leases as finance or operating leases, which may affect the accounting treatment.

A finance lease, as defined by IFRS 16, is a lease where the risks and rewards of ownership transfer from the lessor to the lessee. As mentioned above in Indicators of a finance lease and as described in scenario, despite some indications of an operating lease, factors like lessee's ability to continue the lease at a low cost, inability to cancel without penalty, and substantial lease payments suggest that the lease is a finance lease.