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Accounting for leases

□ To classify a lease, a lessee should use all lease payments (i.e., including payments made before the
commencement date), whereas only the remaining payments due should be used to measure the
lease liability at lease commencement

□ For lease classification purposes, the entire potential payment under a residual value guarantee
should be included in the lease payments. The lease liability recorded at lease commencement
should only include amounts probable of being owed by the lessee under residual value guarantees

See LG 3.3.4.6 and LG 3.3.4 for information on determining the discount rate and lease payments for
lease classification purposes.

4.2.2 Measuring the right-of-use asset

ASC 842-20-30-5 provides guidance on measuring the right-of-use asset at the commencement date.

ASC 842-20-30-5
At the commencement date, the cost of the right-of-use asset shall consist of all of the following:

a. The amount of the initial measurement of the lease liability

b. Any lease payments made to the lessor at or before the commencement date, minus any lease
incentives received

c. Any initial direct costs incurred by the lessee (as described in paragraphs 842-10-30-9 through
30-10).

The items added to the lease liability to determine the costs of the right-of-use asset are discussed in
the following sections.

4.2.2.1 Payments made at or before the commencement date, less lease incentives received

Lease payments made prior to lease commencement (for use of the underlying asset) should be
recorded as prepaid rent. This prepaid amount should then be reclassified to the right-of-use asset on
the lease commencement date. Thus, the right-of-use asset is increased for any lease payments made
by a lessee at or before the lease commencement date. See LG 3.3.4.2 for information on lease
incentives.

4.2.2.2 Initial direct costs

Initial direct costs should be recorded as an increase in the lessee’s right-of-use asset but should not be
recorded as part of the lease liability.

Initial direct costs are incremental costs of a lease that would not have been incurred had the lease not
been executed. Costs directly or indirectly attributable to negotiating and arranging the lease (e.g.,
external legal costs to draft or negotiate a lease or an allocation of internal legal costs) are not
considered initial direct costs. Figure 4-1 provides examples of costs included and excluded from
initial direct costs.

4-3