In short
A lessee discounts lease payments using the rate implicit in the lease if it is readily determinable. If not, it uses its incremental borrowing rate: the rate it would pay to borrow, on a collateralized basis over a similar term, an amount equal to the lease payments.
Key takeaways
- Lessees usually can't determine the implicit rate, so they use this one.
- Private companies can elect a risk-free rate by class of asset instead.
- A lower discount rate gives a larger lease liability.
Where it's tested
FAR: Leases — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
A lessee signs a five-year lease with annual year-end payments of $20,000 and a discount rate of 6%. The present value factor for an ordinary annuity of five payments at 6% is 4.2124. What is the initial lease liability?