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Modification and remeasurement of a lease

The lease has the following terms:

Lease commencement date January 1, 20X1

Initial lease term 5 years with no renewal option

Economic life 30 years

Annual lease payments $1,000,000

Incremental borrowing rate 5%

Lease incentive Lessor Corp agrees to reimburse Lessee Corp up
to $300,000 for leasehold improvements
completed within the first two years of the lease

Payment date Annually on January 1

Lease classification Operating lease

Since it is unlikely Lessee Corp would forgo any lease incentive it negotiated to receive from Lessor
Corp, Lessee Corp accounts for the incentive as an in-substance fixed payment to be received from
Lessor Corp. Lessee Corp expects that it will complete the improvements two years after lease
commencement and records a receivable (i.e., a negative lease payment) when calcuating the lease
liablity based on that expected timing. The lease liability at commencement is $4,273,842 and is
calculated as follows:

1/1/X1 1/1/X2 12/31/X2 1/1/X3 1/1/X4 1/1/X5 Total

Lease
payment $1,000,000 $1,000,000 (300,000) $1,000,000 $1,000,000 $1,000,000 $4,700,000

Discount 0 (47,619) 27,891 (92,971) (136,162) (177,298) (426,158)

Present
value $1,000,000 $952,381 (272,109) $907,029 $863,838 $822,702 $4,273,842

Lessee Corp finishes the leasehold improvements in one year (as opposed to the original estimate of
two years) and utilizes the entire lease incentive of $300,000. The payment for the lease incentive was
received on 12/31/X1.

How should Lessee Corp account for the difference in timing from the original estimate?

When the timing of the receipt of the lease incentive changes from the original estimate at
commencement, the lease liability must be remeasured using the discount rate at lease
commencement. In this example, the lease liability is remeasured at 12/31/x1 (concurrent with the
receipt of the incentive payment).

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