Which of the following accounts would not appear on the income statement of a lessee in connection with a finance lease? A. Amortization expense B. Interest expense C. Property tax expense D. Rental expense
The correct answer and explanation is:
Correct Answer: D. Rental expense
In a finance lease, the lessee essentially treats the leased asset as if it were purchased with borrowed funds. Under the current lease accounting standards, the lessee records a right-of-use asset and a lease liability on the balance sheet at the commencement of the lease. Over the lease term, the lessee must recognize two main expenses related to the lease on the income statement: amortization expense and interest expense.
Amortization expense represents the systematic allocation of the cost of the right-of-use asset over the lease term, similar to depreciation for owned assets. Interest expense arises from the unwinding of the lease liability, reflecting the cost of financing the asset over time.
Property tax expense could appear on the lessee’s income statement if the lease agreement makes the lessee responsible for paying property taxes directly. This situation often happens in leases where the lessee must maintain and operate the asset as if it were owned.
Rental expense, however, is associated with operating leases, not finance leases. In an operating lease, the lessee records lease payments as rental expense on a straight-line basis over the lease term. There is no recognition of a right-of-use asset being amortized or a lease liability being reduced by an interest component under the old standard for operating leases. However, under new standards like IFRS 16 and ASC 842, most leases go on the balance sheet, but for a finance lease specifically, the expense is split into amortization and interest, not recorded as a single rental expense.
In summary, for a finance lease, amortization expense and interest expense are expected. Property tax expense may arise depending on the lease terms. Rental expense does not appear because the lessee does not treat payments as a simple rental cost but rather as part of amortization and interest components. Therefore, rental expense is the account that would not appear on the income statement for a finance lease.