Under a finance lease, how is the asset and liability treated on the lessee's books?

• A. Recorded as rental expense only
• B. Recorded as an asset and a liability
• C. Not recorded at all until payments are made
• D. Recorded as equity only

Answer: (B)

In a finance lease, the lessee records both a right-of-use asset and a lease liability on the balance sheet, reflecting the right to use the asset and the obligation to make lease payments. The asset and liability are initially measured at the present value of the minimum lease payments (plus any initial direct costs for the asset), and thereafter the liability is reduced by payments while accruing interest, and the asset is depreciated over the shorter of the lease term or the asset’s useful life. Because of this, the income statement shows depreciation and interest expense rather than a single rental expense. This balance-sheet recognition distinguishes finance leases from operating leases, which typically involve recognizing rental expense only.