Example LG 4-1,Example LG 4-2,Example LG 4-3,Example LG 4-4,Example LG 4-5,andExample LG 4-6illustrate the measurement of a right-of-use asset and a lessee's accounting for leases.
EXAMPLE LG 4-1
Measuring the right-of-use asset
Lessee Corp and Lessor Corp execute a 10-year lease of a railcar with the following terms on January 1, 20X9:
- The lease commencement date is February 1, 20X9.
- Lessee Corp must pay Lessor Corp the first monthly rental payment of $10,000 upon execution of the lease.
- Lessor Corp will pay Lessee Corp a $50,000 cash incentive to enter into the lease payable upon lease execution.
Lessee Corp incurred $1,000 of initial direct costs, which are payable on February 1, 20X9.
Lessee Corp calculated the initial lease liability as the present value of the remaining unpaid lease payments discounted using its incremental borrowing rate because the rate implicit in the lease could not be readily determined; the initial lease liability is $900,000.
How would Lessee Corpmeasure the right-of-use assetand record this lease?
Analysis
Lessee Corp wouldmeasurethe right-of-use asset as follows:
Initial measurement of lease liability | $900,000 |
Lease payments made to Lessor Corp before the commencement date (i.e., before the first lease payment) | 10,000 |
Lease incentive received from Lessor Corpat lease execution date | (50,000) |
Initial direct costs | 1,000 |
Initial measurement of right-of-use asset | $861,000 |
On January 1, 20X9 (the lease execution date), Lessee Corp would record the following journal entries:
Dr. Prepaid rent | $10,000 | |
Cr. Cash | $10,000 | |
To record the initial lease payment due at lease inception | ||
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Dr. Cash | $50,000 | |
Cr. Lease incentive | $50,000 | |
To record receipt of the lease incentive from the lessor. | ||
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On February 1, 20X9 (the lease commencement date), Lessee Corp would record the following journal entries:
Dr. Right-of-use asset | $900,000 | |
Cr. Lease liability | $900,000 | |
To record the right-of-use asset and lease liability | ||
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Dr. Lease incentive | $50,000 | |
Cr. Right-of-use asset | $50,000 | |
To reclassify the lease incentive as an offset to the right-of-use asset | ||
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Dr. Right-of-use asset | $10,000 | |
Cr. Prepaid rent | $10,000 | |
To reclassify the prepaid rent as an offset to the right-of-use asset | ||
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Dr. Right-of-use asset | $1,000 | |
Cr. Accrued expenses | $1,000 | |
To record the initial direct costs |
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EXAMPLE LG 4-2
Finance lease initial recognition – non-specialized digital imaging equipment lease (lessee)
Lessee Corp enters into a lease of non-specialized digital imaging equipment with Lessor Corp on January 1, 20X9. The following table summarizes information about the lease and the leased assets.
Lease term | 5 years, no renewal option |
Remaining economic life of the leased equipment | 6 years |
Purchase option | None |
Annual lease payments | $1,100 |
Payment date | Annually on January 1 (first payment made at lease commencement) |
Lessee Corp’s incremental borrowing rate | 7% The rate Lessor Corp charges Lessee Corp in the lease is not readily determinable by Lessee Corp. |
Other |
|
How would Lessee Corp measure and record this leaseat commencement?
Analysis
Based on the facts Lessee Corp could reasonably conclude that the lease is a finance lease as the lease term is a major part of the remaining economic life of the equipment (see LG 3.3 for lease classification criteria).
Lessee Corp would first calculate the lease liability as the present value of the four remaining unpaid annual fixed lease payments of $1,100 discounted at Lessee Corp's incremental borrowing rate of 7%; this amount is $3,725.
The right-of-use asset is equal to the lease liability plus the $1,100 rent paid on the lease commencement date.
Lessee Corp would record the following journal entry on the lease commencement date.
Dr. Right-of-use asset | $4,825 | |
Cr. Lease liability | $3,725 | |
Cr. Cash | $1,100 |
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SeeExample LG 4-11for an illustration of the subsequent measurement and recognition for this fact pattern.
EXAMPLE LG 4-3
Finance lease recognition – real estate lease with a purchase option (lessee)
Lessee Corp enters into a property (land and building) lease with Lessor Corp on January 1, 20X9. The following table summarizes information about the lease and the leased asset.
Lease term | 10 years |
Renewal option | Five 5-year renewal options If exercised, the annual lease payments are reset to then current market rents |
Remaining economic life | 40 years |
Fair value of the leased propertyat commencement | $5,000,000 |
Purchase option | Lessee Corp has an option to purchase the property at the end of the lease term for $3,000,000. Lessee Corp is reasonably certain to exercise this option. |
Annual lease payments | The first annual lease payment is $500,000, with increases of 3% per year thereafter (see schedule of lease payments below). |
Payment date | Annually on January 1 (first payment made at lease commencement) |
Incentive | Lessor Corp gives Lessee Corp a $200,000 incentive for entering into the lease (payable at the beginning of year 2), which is to be used for normal tenant improvements. |
Lessee Corp's incremental borrowing rate | 9.04% The rate that Lessor Corp charges Lessee Corp in the lease is not readily determinable by Lessee Corp. |
Other |
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The schedule of lease payments (excluding the purchase option) is shown below.
Date | Amount |
Year 1 (paid at commencement) | $500,000 |
Year 2($515,000 – $200,000 lease incentive) | 315,000 |
Year 3 | 530,450 |
Year 4 | 546,364 |
Year 5 | 562,754 |
Year 6 | 579,637 |
Year 7 | 597,026 |
Year 8 | 614,937 |
Year 9 | 633,385 |
Year 10 | 652,387 |
Total | $5,531,940 |
How would Lessee Corp measure and record this leaseat commencement?
Analysis
Based on the facts Lessee Corp could reasonably conclude that the lease is a finance lease because the fixed price purchase option is reasonably certain to be exercised (see LG 3.3 for lease classification criteria).
Lessee Corp would first calculate the lease liability as the present value of the remaining unpaid annual lease payments, less the lease incentive paid in year 2, plus the exercise price of the purchase option using a discount rate of 9.04%.
PV of annual lease payments, less lease incentive | $3,237,510 |
PV of purchase option at end of lease term | 1,262,490 |
Total lease liability | $4,500,000 |
The right-of-use asset is equal to the lease liability plus the $500,000 rent paid on the lease commencement date ($5,000,000).
Lessee Corp would record the following journal entry on the lease commencement date.
Dr. Right-of-use asset | $5,000,000 | |
Cr. Lease liability | $4,500,000 | |
Cr. Cash | $500,000 |
View table
SeeExample LG 4-12for an illustration of the subsequent measurement and recognition for this fact pattern.
EXAMPLE LG 4-4
Lessee operating lease recognition – automobile lease
Lessee Corp leases an automobile from Lessor Corp on January 1, 20X9. The following table summarizes information about the lease and the leased asset.
Lease term | 3 years, no renewal option |
Remaining economic life of the automobile | 6 years |
Purchase option | Lessee Corp has the option to purchase the automobile at fair market value upon expiration of the lease. |
Monthly lease payments | $500 (first payment made at lease commencement) |
Payment date | Beginning of the month |
Lessee Corp’s incremental borrowing rate | 6% The rate Lessor Corp charges Lessee Corp in the lease is not readily determinable by Lessee Corp. |
Other |
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How would Lessee Corp measure and record this leaseat commencement?
Analysis
Based on the facts Lessee Corp could reasonably conclude that this lease is an operating lease as none of the criteria for finance lease classification are met (see LG 3.3 for lease classification criteria).
Lessee Corp would first calculate the lease liability as the present value of the remaining unpaid monthly fixed lease payments discounted at Lessee Corp's incremental borrowing rate of 6%; this amount is $16,018.
The right-of-use asset is equal to the lease liability plus the $500 rent paid on the lease commencement date ($16,518). Lessee Corp would record the following journal entry on the lease commencement date.
Dr. Right-of-use asset | $16,518 | |
Cr. Cash | $500 | |
Cr. Lease liability | $16,018 |
View table
SeeExample LG 4-13for an illustration of the subsequent measurement and recognition for this fact pattern.
EXAMPLE LG 4-5
Lessee operating lease recognition
Lessee Corp leases a copier from Lessor Corp on January 1, 20X9. The following table summarizes information about the lease and the leased asset.
Lease term | 3 years, no renewal option |
Remaining economic life of the copier | 5 years |
Purchase option | None |
Annual lease payments | $500, which includes Lessor Corp maintenance for the term of the lease Lessor Corp normally leases the same copier for $475 per year and offers a maintenance contract for $75 per year. |
Payment date | Annually on January 1 (first payment made at lease commencement) |
Lessee Corp’s incremental borrowing rate | 5.5% The rate Lessor Corp charges Lessee Corp in the lease is not readily determinable by Lessee Corp. |
Other |
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Lessee Corp has not made an accounting policy election to not separate the lease and nonlease components for this class of asset.
How would Lessee Corp measure and record this leaseat commencement?
Analysis
The arrangement contains a copier lease (lease component) and maintenance (nonlease component). An allocation of the annual $500 fixed payment between the copier lease and maintenance would be made as follows:
Standalone price (A) | Relative % (A/$550) | Annual fixed | Allocated annual | |
Annual copier lease payment | $475 | 86.4% | $500 | $432 |
Annual maintenance contract fee | 75 | 13.6% | $500 | 68 |
Total | $550 | 100% | $500 |
Based on the facts Lessee Corp could reasonably conclude that the lease is an operating lease as none of the criteria for finance lease classification are met (see LG 3.3 for classification criteria).
Lessee Corp would first calculate the lease liability as the present value of the remaining unpaid annual allocated lease payment amount of $432 discounted at Lessee Corp's incremental borrowing rate of 5.5%; this amount is $798.
The right-of-use asset is the sum of the lease liability, plus the $432 lease payment made on the lease commencement date and the initial direct costs paid by Lessee Corp ($100); this amount is $1,330 ($798 + $432+ $100).
Lessee Corp would record the following journal entry on the lease commencement date.
Dr. Right-of-use asset | $1,330 | |
Cr. Lease liability | $798 | |
Cr. Cash | $532 |
View table
EXAMPLE LG 4-6
Lessee operating lease recognition – lease payments tied to an index
Lessee Corp enters into a lease of equipment with Lessor Corp on January 1, 20X9. The following table summarizes information about the lease and the leased assets.
Lease term | 4 years, no renewal option |
Remaining economic life of the leased equipment | 7 years |
Purchase option | None |
Annual lease payments | The first annual payment is $1,500 The annual payment increases each year by the prime rate on January 1st. For example, if the prime rate is 3% on January 1, 201X, then the lease payment for year two would be $1,545 ($1,500 + ($1,500 × 3%)). |
Payment date | Annually on January 1 (first payment made at lease commencement) |
Lessee Corp’s incremental borrowing rate | 8% The rate Lessor Corp charges Lessee Corp in the lease is not readily determinable by Lessee Corp. |
Other |
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Prime rate at the lease commencement date is 3%. The lease payments based on the prime rate at commencement are:
Date | Amount |
Lease commencement | $1,500 |
Year 2 | 1,545 |
Year 3 | 1,591 |
Year 4 | 1,639 |
Total | $6,275 |
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How would Lessee Corp measure and record this lease atcommencement?
Analysis
Based on the facts, Lessee Corp could reasonably conclude that the lease is an operating lease as none of the criteria for finance lease classification are met (see LG 3.3 for classification criteria).
Lessee Corp would first calculate the lease liability as the present value of the remaining unpaid fixed lease payments plus the variable lease payment (based on the Prime rate at the lease commencement date) discounted at Lessee Corp's incremental borrowing rate of 8%; this amount is $4,096. Even if the Prime rate is expected to increase each year, the lease payments must be calculated using the rate at lease commencement and the rate will only be updated upon certain lease remeasurement events (see LG 5).
The right-of-use asset is equal to the lease liability plus the first lease payment made at lease commencement ($5,596).
Lessee Corp would record the following journal entry on the lease commencement date.
Dr. Right-of-use asset | $5,596 | |
Cr. Lease liability | $4,096 | |
Cr. Cash | $1,500 |
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