If the lessor and lessee use different interest rates to account for a finance lease, then
a. The lessor will use different account titles to record the leasing transactions
b. Total expenses and revenues will be equal
c. Total expenses and revenues will be different
d. The lessee and the lessor cannot use different interest rates
The correct answer and explanation is :
The correct answer is:
c. Total expenses and revenues will be different
Explanation:
When lessors and lessees use different interest rates to account for a finance lease, it results in different accounting treatments for the lease transactions on their respective financial statements. This is primarily due to how the interest expense and revenue are recognized and calculated.
- Lessee’s Perspective:
The lessee records a liability for the present value of lease payments, which is typically the sum of the lease payments, discounted at the lessee’s incremental borrowing rate (or the rate implicit in the lease, if known). Over the life of the lease, the lessee recognizes interest expense on the lease liability. The interest expense is based on the rate the lessee uses for the discounting of the lease obligation. - Lessor’s Perspective:
The lessor also recognizes the lease transaction differently. For the lessor, the interest income is calculated using the rate implicit in the lease (or the rate at which they would earn a return on the lease agreement). The lessor’s recognition of revenue from the lease is based on this interest rate.
Since the lessee and the lessor typically use different rates—often the lessee’s incremental borrowing rate versus the rate implicit in the lease—each party’s calculation of interest expense or income differs. Consequently, the total expenses (for the lessee) and revenues (for the lessor) are not the same, leading to different amounts being recognized in their financial statements.
This discrepancy arises because the lessor typically uses the rate implicit in the lease, which reflects the total amount the lessor expects to receive from the lease, including interest. The lessee, on the other hand, uses their borrowing rate, which is often higher or lower than the rate implicit in the lease depending on the lease’s structure and risk factors.
Therefore, the overall total expenses (interest) recognized by the lessee and the total revenues (interest income) recognized by the lessor will differ due to the different rates used to discount the cash flows.