How should the lessee record a capital lease on the income statement?

How should the lessee record a capital lease on the income statement?

• A. Each minimum payment is recorded as an expense
• B. Allocated between reduction of obligation and interest expense
• C. Recognized as depreciation only
• D. Not disclosed on income statement

Answer: (B)

For a capital (finance) lease, the lessee records the leased asset and a corresponding lease liability. On the income statement, the lease affects two things: interest expense on the lease liability and depreciation expense on the leased asset. The cash payments are split into two parts: the interest portion is recognized as interest expense, and the principal portion reduces the lease obligation (a balance‑sheet effect). The asset is also depreciated, which adds depreciation expense to the income statement. Therefore, the correct approach is to allocate each lease payment between reducing the lease obligation (principal) and recognizing interest expense, with depreciation shown separately for the asset. The other options misstate the treatment by treating payments as a single expense, omitting interest, or omitting the impact on the income statement.

For a capital (finance) lease, the lessee records the leased asset and a corresponding lease liability. On the income statement, the lease affects two things: interest expense on the lease liability and depreciation expense on the leased asset. The cash payments are split into two parts: the interest portion is recognized as interest expense, and the principal portion reduces the lease obligation (a balance‑sheet effect). The asset is also depreciated, which adds depreciation expense to the income statement. Therefore, the correct approach is to allocate each lease payment between reducing the lease obligation (principal) and recognizing interest expense, with depreciation shown separately for the asset. The other options misstate the treatment by treating payments as a single expense, omitting interest, or omitting the impact on the income statement.