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Accounting for leases

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

Lessee Corp determines that the lease is an operating lease.

How would Lessee Corp measure and record this lease?

Analysis

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

4.3 Initial recognition and measurement – lessor

As discussed in LG 3, leases are classified by a lessor as either a sales-type, direct financing, or
operating lease. While lessees are required to record a lease liability and right-of-use asset for all
leases, the model applied by lessors depends on the type of the lease.

When a lease is not a sales-type lease but meets the criteria to be classified as a direct financing lease,
the lease transaction effectively converts the lessor’s risk arising from the underlying asset (that is,

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