Western Governors University (WGU) ACCT3650 D105 Intermediate Accounting III Practice Exam

In a finance lease, each lease payment is comprised of two key components: the reduction of the lease liability and the financing cost. The reduction of the lease liability occurs as the lessee makes payments over the lease term, gradually decreasing the outstanding principal owed. This reduction reflects the amortization of the liability recognized on the balance sheet.

The financing cost, on the other hand, represents the interest component of the lease payment. This interest expense is calculated based on the outstanding balance of the lease liability and is recognized in the period that the payment is made.

Together, these two elements accurately encapsulate how lease payments are structured in finance leases, reflecting both the obligation to repay the principal and the cost of borrowing the funds necessary to finance the leased asset.

The other choices focus on components that are not part of the lease payment structure or misunderstand the accounting principles related to leases in this context. For example, asset depreciation is a separate accounting treatment related to the leased asset itself rather than the payment structure, while the guaranteed residual value is not part of each payment but rather affects the total lease liability and overall cash flow considerations at lease termination.