Damon is the lessee in connection with a finance lease. Damon will not record: Question 6 options: 1) Depreciation expense. 2) Amortization expense. 3) Interest expense. 4) A right-of-use asset.
The correct answer and explanation is:
Correct Answer: 1) Depreciation expense.
Explanation:
Under ASC 842, which governs lease accounting, a finance lease (formerly known as a capital lease) requires the lessee (in this case, Damon) to recognize both a right-of-use (ROU) asset and a lease liability on the balance sheet at the commencement date of the lease.
What Damon will record:
- Right-of-use (ROU) asset – Damon must record this to reflect his right to use the leased asset over the lease term.
- Lease liability – This represents Damon’s obligation to make lease payments.
- Amortization expense – The ROU asset is amortized (not depreciated in the traditional sense) over the lease term, typically using the straight-line method. This is similar to how intangible assets are treated.
- Interest expense – The lease liability is accounted for using the effective interest method, resulting in interest expense that is higher in earlier years and decreases over time.
Key Distinction:
- Depreciation expense typically applies to owned tangible assets and is recorded by the owner of the asset.
- Since Damon does not own the underlying asset but only has the right to use it under a finance lease, he will not record depreciation expense.
- Instead, amortization expense is recorded for the right-of-use asset.
This accounting treatment helps reflect both the use of the asset and the financing component of the lease on Damon’s income statement and balance sheet.
Summary:
Damon, as a lessee under a finance lease, will record:
- A right-of-use asset ✔
- A lease liability ✔
- Amortization expense ✔
- Interest expense ✔
❌ But he will not record depreciation expense, making option 1 the correct answer.