In finance and operating leases, how are interest payments treated in cash flows?

In the context of finance and operating leases, the treatment of interest payments in cash flows is based on the classification of the lease. For finance leases, the lessee recognizes both the interest expense and the amortization of the lease asset. The interest portion of the lease payment is considered an operating cash flow because it is an expense recognized in the income statement. However, the principal portion of the lease liability is treated as a financing cash flow since it represents a reduction of the debt incurred to finance the asset.

In contrast, for operating leases, the entirety of the lease payment is treated as an operating cash flow. There is no separate recognition of principal and interest since the lease payments are generally recognized as a rental expense in the income statement.

Therefore, the correct answer notes that for finance leases, interest payments are categorized as operating cash flows, while the principal payments are considered financing cash flows. This differentiation provides a clear view of how lease liabilities impact cash flow statements for different types of leases, aligning with the relevant accounting principles.