Under US GAAP, only i.e. not under IRS. Companies can choose whether to use finance or operating leases. However, there are criteria that have to be met when making that choice. Let's have a look at the finance lease criteria under US GAAP. Now, we can sum up these criteria by saying if most of an asset's life is taken up by the lease period, or most of the asset's value is taken up by the lease, then we have to use finance leases. Let's look at the criteria in detail.

If ownership transfers at the end of the lease term or an option to purchase is reasonably expected to be exercised, or the lease term is the major portion of the economic life, or the present value of lease payments and residual guarantee is greater than or equal to the fair value of the asset, or the asset is so specialized that no alternative use can be found, then companies must use the finance lease criteria under US GAAP.

If those finance lease criteria are not met, then a company can choose to use operating leases for its accounting of leases instead. However, there aren't that many differences here. First of all, an asset is seen on the balance sheet, and this is the same as under finance leases. There's also a liability on the balance sheet, same as finance leases, but on the income statements, the income statement expenses, the cash lease expense in operational costs under finance lease, this would be split into depreciation and interest.

So under operating leases, there is no interest or depreciation shown on the income statements. Instead, you just see it all lumped together as one being the cash lease expense.

So that's your major difference between finance leases and operational leases. Under an operating lease, you're going to see the cash lease expense in the income statements, whereas under a finance lease, you would see an interest and depreciation split out of that expense.