Question

Morgan Handley and Tricia Holbrook are discussing the new leasing standard. Morgan believes the standard requires that the lessee use the implicit rate of the lessor in computing the present value of its lease liability. Tricia is not sure if Morgan is correct. Explain the discount rate that the lessee should use to compute its lease liability.

Answer 1

The lessee will require the rate in computing the present value of its lease liability .The lessee is required to find out its lease liability by taking the implicit rate in the lease if that rate is readily determined or if implicit rate is not available lessee can use incremental borrowing rate .The lessor will always have to use the implicit rate of return in the lease.

The implicit rate in the lease is the present value of annual lease payments ,any unguarantee residual value of the asset and any initial direct cost of the lessor.Incremental borrowing rate is the rate of interest that have to be paid on borrowing with the similar term having similar security in the similar economic environment.

The lessee should use to compute its lease liability the implicit rate if readily determined or else if implicit rate not known to him he can use incremental borrowing rate.