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Modification and remeasurement of a lease

Lessee Corp determines that the lease at inception is an operating lease. Lessee Corp’s incremental
borrowing rate at the lease inception date is 5% (this rate does not reflect the renewal option). The CPI
at lease commencement is 120.

At the lease commencement date, Lessee Corp did not have a significant economic incentive to
exercise the renewal option. In the first quarter of 20X4, Lessee Corp installed unique tenant
improvements into the retail store with an estimated five-year economic life. Lessee Corp determined
that it would only recover the cost of the improvements if it exercises the renewal option, creating a
significant economic incentive to extend.

Installing the improvements was a signficant event controlled by Lessee Corp, which is now reasonably
certain that it will exercise its renewal option. Lessee Corp is therefore required to remeasure the lease
in the first quarter of 20X4.

Lessee Corp reassesses the lease classification and determines that it is still an operating lease.

The following table summarizes information pertinent to the lease remeasurement.

Remeasured lease term 5 years; 2 years remaining in the initial
term plus 3 years in the renewal period

Lessee Corp’s incremental borrowing rate
on the remeasurement date 6%

CPI available on the remeasurement date 125

Right-of-use asset immediately before the
remeasurement $199,238

Lease liability immediately before the remeasurement $195,238

How would Lessee Corp account for the remeasurement?

Analysis

Balance sheet impact

To remeasure the lease liability, Lessee Corp would first calculate the present value of the future lease
payments for the new lease term (using the updated discount rate of 6%). The following table shows
the present value of the future lease payments based on an updated CPI of 125. Since the initial lease
payments were based on a CPI of 120, the CPI has increased by 4%. As a result, Lessee Corp would
increase the future lease payments by 4% for those payments in the initial lease term (years 4 and 5).
As shown in the table, the revised lease liability would be $490,597.

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