What does the lessee record for subsequent entries in a finance lease?

In a finance lease, the lessee is required to recognize both the interest component of the lease liability and the principal repayment of that liability over the lease term. This is akin to how bonds or other long-term debt is treated.

When the lessee makes a payment under a finance lease, part of the payment goes toward reducing the outstanding lease liability (the principal), and part of the payment is recognized as interest expense on the lease liability. As a result, the entry includes debiting interest expense to record the cost associated with borrowing, debiting the lease liability to reflect the reduction in the amount owed, and crediting cash or a lease payable account to indicate the outflow of cash for the total lease payment made.

This accounting treatment aligns with the requirements under ASC 842, where finance leases are treated similarly to debt. This ensures that both the expense from using the asset (interest expense) and the liability for the asset’s purchase (lease liability) are accurately reflected in the financial statements.

The other options do not correctly capture the nature of lease payments in a finance lease setting, as they present different transactions or accounting treatments that do not adhere to the financial reporting requirements of a finance lease.