ACCA Financial Reporting (F7) Practice Exam

How is interest expense treated in lease payments?

1. It is recorded as an asset

2. It is treated as an operating expense

3. It is added to the total lease liability

4. It is included in the total lease payments

The correct answer is: It is included in the total lease payments

In lease accounting, specifically under the IFRS 16 framework, interest expense is an integral part of the financial treatment of lease payments. When a lease is recognized on the balance sheet, the lessee records a lease liability, which represents the present value of future lease payments, and a corresponding right-of-use asset. The total lease payments consist of both the principal portion and the interest expense related to that lease liability. Each lease payment is divided between interest and the reduction of the lease liability. The interest expense reflects the cost of borrowing associated with the lease liability and is calculated using the effective interest rate method. Thus, identifying that interest expense is included in the total lease payments aligns with the correct treatment under IFRS guidelines. It effectively highlights that interest is a cost that is recognized over the lease term, affecting both the income statement and the balance sheet, ultimately influencing profitability and financial ratios for lessees. Recognition of interest expense in the total lease payments is crucial as it impacts cash flow planning and expense management for the entity, ensuring all components related to lease liabilities are transparently reported.