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Accounting for leases

Interest expense on the lease liability would be calculated as shown in the following table. This table
includes all expected cash flows during the lease term, including the lease incentive paid by Lessor
Corp and Lessee Corp’s purchase option. See Example 4-3 for a schedule of payments.

Lease liability
Payment Interest expense (end of year)

Lease commencement $4,500,000

Year 1 $0* $406,840 4,906,840

Year 2 315,000** 415,143 5,006,983

Year 3 530,450 404,718 4,881,251

Year 4 546,364 391,912 4,726,800

Year 5 562,754 376,466 4,540,511

Year 6 579,637 358,098 4,318,972

Year 7 597,026 336,497 4,058,443

Year 8 614,937 311,323 3,754,829

Year 9 633,385 282,206 3,403,650

Year 10 652,387 248,737 3,000,000

Year 10 3,000,000 — —
1
$8,031,940 $3,531,940

* No payment is reflected in Year 1 because the Year 1 payment was made at lease commencement and is not
included in the lease liability.
** In Year 2, a payment of $515,000 was made but the lease incentive of $200,000 was also received.

1 Exercise of purchase option at the end of term
Although the lease was for 10 years, the asset had an economic life of 40 years. When Lessee Corp
exercises its purchase option at the end of the 10-year lease, it would have fully extinguished its lease
liability but continue depreciating the asset over the remaining useful life.

4.4.2 Operating leases

Operating lease expense is recorded in a single financial statement line item on a straight-line basis
over the lease term. This differs from finance lease expense recognition which is typically higher in the
earlier years of a lease and declines over time.

4-31