What is a financial lease and how does it influence reported debt?

• A. A lease recognized as an operating expense, with no balance sheet impact.
• B. A lease classified as an operating expense only; does not affect leverage.
• C. A lease is always off-balance-sheet, not affecting debt covenants.
• D. A lease treated as both an asset and a liability; increases leverage and may affect debt covenants.

Answer: (D)

A finance lease creates a balance‑sheet footprint: you record a right‑of‑use asset and a lease liability for the present value of future payments. That means reported debt goes up, because the lease liability is treated as a form of debt and enters leverage calculations and debt covenants. The income statement reflects depreciation on the asset and interest on the liability, rather than just one lease expense.

This is different from an operating lease, where the lease payments are typically expensed and may not raise leverage in the same way on the balance sheet (under older treatment). So the correct idea is that a lease is recorded as both an asset and a liability, increasing leverage and potentially affecting debt covenants.