Under a finance lease, the lessee typically records which on the balance sheet?

• A. Only an asset.
• B. An asset and a liability.
• C. Only a liability.
• D. Only an expense.

Answer: (B)

In a finance lease, the lessee effectively finances the use of an asset, so two balance sheet items appear: a right-of-use asset representing the use of the underlying asset, and a lease liability representing the obligation to make lease payments. The liability is the present value of minimum lease payments, discounted at the rate the lessee would have borrowed at (the rate implicit in the lease if determinable, otherwise the incremental borrowing rate). This pairing captures that the lessee both controls the asset for the lease term and owes future payments. Over time, the asset is depreciated and the liability is reduced as payments are made, with interest expense recognized on the liability. Hence, both an asset and a liability are recorded on the balance sheet.