How do I measure the lease liability and right-of-use asset at lease commencement?

Question

AcadiFi · Accepted Answer

At commencement, the lease liability equals the present value of lease payments not yet paid, discounted at the rate implicit in the lease if known or the lessee's incremental borrowing rate if not. The right-of-use asset starts with the lease liability, then adds prepaid rent and initial direct costs, and subtracts lease incentives received from the lessor.

Example: Blue Mesa Packaging signs a 4-year office lease with annual end-of-year payments of $90,000. The present value of those payments at the appropriate discount rate is $318,000. Blue Mesa also pays $12,000 of initial direct costs, prepays $20,000 of rent at commencement, and receives a $15,000 lease incentive from the landlord. The lease liability is $318,000. The right-of-use asset is $318,000 + $12,000 + $20,000 - $15,000 = $335,000.

```mermaid
flowchart TD
  A[PV of lease payments] --> B[Lease liability]
  B --> C[Add direct costs]
  C --> D[Add prepaid rent]
  D --> E[Less incentives]
  E --> F[ROU asset]
```

A common FAR mistake is forcing the liability and asset to be the same amount in every case. They are often different once direct costs, incentives, or prepayments are involved. Also remember that operating and finance leases start with the same measurement idea for the balance sheet. The big difference shows up later in expense pattern and income statement presentation. Practice more in our CPA FAR question bank.

How do I measure the lease liability and right-of-use asset at lease commencement?

Master FAR with our CPA Course

Related Questions

Practice Questions