2024 CPA FAR Exam-Operating Leases-Darius Clark

In accounting under US GAAP, an operating lease lasts longer than a year but doesn’t meet one of the five requirements for a finance lease. In an operating lease, interest is calculated but not recognized. In a finance lease, the same amount of interest is calculated and is also recognized. The asset and liability must be recorded on the lessee’s books at lease inception. At lease inception, lessee records a “right of use” asset and a “lease liability.” The amount of lease liability recorded by the lessee is the present value of the lease payments. Present value computations require the use of an appropriate interest rate. The interest rate used in the present value calculation is the lessee’s incremental borrowing rate unless the lessor’s implicit rate is known to the lessee, then use the lessor’s implicit interest rate. Using the implicit rate captures the return that the lessor expects to earn from the lease. When the lessee knows the lessor’s implicit rate, the lessee uses it to calculate the present value of the lease payments instead of using the lessee’s rate.