FAR · Select transactions · 9 practice questions
ASC 842: Calculate lease liability and ROU asset (example)
Under ASC 842, the lease liability is the present value of unpaid lease payments, and the ROU asset adjusts that amount for upfront items. Below: a worked calc example with steps, plus common traps.
Try one first
Hint
First determine which lease payments are still owed after commencement, then adjust the right-of-use asset for amounts paid or received at commencement.
Answer D. The lease liability excludes the payment made at commencement. Discount the remaining three payments: $50,000 × (1/1.08 + 1/1.08^2 + 1/1.08^3) = $128,855. The ROU asset equals the liability plus the $50,000 commencement payment plus $3,000 initial direct costs minus the $6,000 lease incentive: $128,855 + $50,000 + $3,000 - $6,000 = $175,855.
Why not A: This properly excludes the immediate payment from the liability and reduces the asset for the lease incentive, but it omits adding the $3,000 of initial direct costs to the ROU asset, understating the asset.
Why not B: Tempting if a candidate incorrectly includes all four payments when measuring the lease liability. Under ASC 842, the liability excludes the payment made at commencement because it is paid immediately; that payment affects the ROU asset instead.
Why not C: This gets the liability right and includes the commencement payment and initial direct costs in the asset, but it fails to reduce the ROU asset for the $6,000 lease incentive received from the lessor, which should decrease the initial asset measurement.
Worked example
On January 1, Year 1, a lessee enters a 4-year lease. Payments are $40,000 at the beginning of each year. A CPI-linked amount adds $1,500 per year measured using the CPI at commencement. The first combined payment of $41,500 is paid on January 1, Year 1. The lessee’s incremental borrowing rate is 7%. The lessee pays $2,500 of qualifying initial direct costs and receives a $5,000 lease incentive at commencement. No nonlease components, no usage- or sales-based variable payments, and no residual value guarantee.
| 1 | Identify unpaid lease payments to discountThree remaining beginning-of-year payments of $41,500 each (Years 2-4) | 3 payments of $41,500 |
| 2 | Present value of unpaid payments (ordinary annuity, 3 periods at 7%)$41,500 × (1/1.07 + 1/1.07^2 + 1/1.07^3) = $41,500 × 2.624316 = $108,909 | $108,909 |
| 3 | Build the ROU asset from the liabilityLease liability $108,909 + commencement payment $41,500 + initial direct costs $2,500 − lease incentive $5,000 | $147,909 |
Initial lease liability $108,909; initial right-of-use asset $147,909.
Check: ROU asset = liability + net upfronts = $108,909 + ($41,500 + $2,500 − $5,000) = $147,909; the paid-at-commencement amount is not in the liability.
Key points
- Use the incremental borrowing rate if the implicit rate is not readily determinable.
- If payments are due at the beginning of each period, exclude the first payment from the liability and discount the rest as an ordinary annuity.
- Include CPI- or rate-indexed amounts using the index in effect at commencement.
- Include amounts probable of being owed under a residual value guarantee in the liability.
- Exclude nonlease components and sales- or usage-based variable payments from initial measurement.
- Refundable security deposits are recorded separately; they do not change the initial liability or ROU asset.
How the exam traps you
- Including the payment made at commencement in the lease liability. Exclude that payment from the liability; add it to the ROU asset as prepaid rent.
- Bundling nonlease components (maintenance, services) into the liability. Separate nonlease components and exclude them from the discounted lease payments.
- Forgetting to adjust the ROU asset for incentives received or initial direct costs. Subtract lease incentives and add qualifying initial direct costs to the ROU asset.
- Discounting sales- or usage-based variable amounts. Exclude variable payments that depend on sales or usage from initial measurement.
Question 2
| Item | Amount |
|---|---|
| Pays the lessor a lease payment due at commencement | $24,000 |
| Pays initial direct costs (incremental costs of obtaining the lease) | $6,000 |
| Receives a cash lease incentive from the lessor | $10,000 |
| Pays the lessor a refundable security deposit | $14,000 |
| Expects to pay variable lease payments over the lease term that depend solely on the equipment's future usage | $18,000 |
Hint
Start with the lease liability amount given, then ask which additional items affect the ROU asset at commencement and which are accounted for separately or later.
Answer D. The lease liability is the present value of lease payments not yet paid, which the stem gives as $300,000. The initial ROU asset equals the lease liability plus lease payments made at or before commencement and initial direct costs, minus lease incentives: $300,000 + $24,000 + $6,000 - $10,000 = $320,000. The refundable security deposit is recorded separately, and usage-based variable payments are excluded from initial measurement under ASC 842.
Why not A: This keeps the lease liability correct but incorrectly adds the $14,000 refundable security deposit to the ROU asset. Refundable deposits are recorded separately and do not increase the ROU asset.
Why not B: This reflects incorrectly adding the $24,000 prepayment to the lease liability (300,000 + 24,000 = 324,000) and then double-counting that prepayment again when building the ROU asset; it also fails to net out the $10,000 lease incentive.
Why not C: This result comes from improperly including the expected $18,000 usage-based variable payments in the initial lease liability (300,000 + 18,000 = 318,000). Variable payments that depend solely on future usage are recognized as incurred and are not included in the initial measurement.
Question 3
Hint
First determine which lease payments are still unpaid at commencement. Then build the right-of-use asset by adjusting the liability for amounts paid at commencement, initial direct costs, and lease incentives.
Answer B. Lease liability equals the present value of the three lease payments remaining after the commencement payment: $30,000 × 2.6730 = $80,190. The initial right-of-use asset = lease liability ($80,190) + payment made at commencement ($30,000) + initial direct costs ($3,000) − lease incentive received ($4,000) = $109,190.
Why not A: This reflects discounting all four payments as if the commencement payment were unpaid and included in the liability. The payment made at commencement is not part of the lease liability; it is added separately when measuring the ROU asset.
Why not C: This has the correct lease liability and includes the commencement payment and initial direct costs in the ROU asset, but it fails to subtract the $4,000 lease incentive. Lease incentives received from the lessor reduce the initial ROU asset.
Why not D: This correctly excludes the first payment from the liability and subtracts the lease incentive, but it omits the $3,000 qualifying initial direct cost that must be capitalized into the initial ROU asset, understating the asset.
Question 4
Hint
Start with the stated lease liability, then ask which commencement-date cash flows and obligations adjust the ROU asset even though they are not part of unpaid lease payments.
Answer D. Initial ROU asset = initial lease liability ($250,000) + payments made at or before commencement ($80,000) + initial direct costs ($6,000) - lease incentive ($10,000) + restoration obligation PV ($8,000). Refundable security deposits, sales-based variable payments, and separate maintenance charges are excluded from initial ROU measurement. Total = 250,000 + 80,000 + 6,000 - 10,000 + 8,000 = $334,000.
Why not A: This reflects including the broker commission, the restoration obligation, and the incentive adjustment but failing to add the $80,000 payment made at commencement, i.e., assuming the $250,000 already included that payment. The stem states the $250,000 is the PV of unpaid lease payments only, so the $80,000 must be added.
Why not B: This shows the candidate included the $80,000 commencement payment, broker commission, and incentive but omitted the $8,000 present value of the restoration obligation, which must be added to the ROU asset.
Why not C: This option incorrectly adds the $14,000 refundable security deposit to the ROU asset. A refundable deposit is expected to be returned and is recorded separately, not included in the initial measurement of the ROU asset.
Question 5
Hint
First determine the lease liability by discounting only the payments not paid at commencement; then adjust that liability to get the ROU asset by adding any payment at or before commencement and qualifying initial direct costs and subtracting any lease incentives.
Answer B. The lease liability at commencement excludes the $50,000 paid at commencement and is the PV of the two remaining beginning-of-period payments: 50,000/1.06 + 50,000/1.06^2 ≈ 47,169.81 + 44,499.82 = $91,670. The ROU asset = lease liability + payment made at or before commencement ($50,000) + qualifying initial direct costs ($3,000) − lease incentives received ($8,000): 91,670 + 50,000 + 3,000 − 8,000 = $136,670.
Why not A: Why tempting: a candidate may correctly compute the PV of the unpaid payments (the lease liability) and stop. Why wrong: the ROU asset must also include payments made at or before commencement, add qualifying initial direct costs, and subtract any lease incentives.
Why not C: Why tempting: this equals the lease liability plus the commencement payment less the incentive (91,670 + 50,000 − 8,000 = 133,670), which looks close. Why wrong: it omits the $3,000 initial direct cost that must be added to the ROU asset under ASC 842.
Why not D: Why tempting: a candidate might add the commencement payment to the lease liability (91,670 + 50,000 = 141,670) and stop. Why wrong: this answer omits both the $3,000 initial direct cost (which should be added) and the $8,000 lease incentive (which should be subtracted); applying those adjustments produces the correct $136,670.
Question 6
Hint
First decide whether the lease is operating or finance under the lessee classification tests. Then determine whether the right-of-use asset is amortized over the lease term or the asset's economic life.
Answer A. The lease meets the finance-lease criterion because the present value of the payments ($240,390) is substantially all of the equipment's fair value ($255,000). A lessee finance lease results in separate interest on the lease liability and amortization of the right-of-use asset. Year 1 interest = $240,390 × 8% = $19,231 (rounded); amortization = $240,390 ÷ 6 = $40,065 (amortize over the 6-year lease term because ownership does not transfer and there is no purchase option).
Why not B: This is tempting because the lease term (6 of 10 years) is not a clear "major part" of the economic life, which might suggest operating classification. However, the present value test shows the PV is substantially all of fair value, which makes this a finance lease, so you do not present a single cash-based lease expense.
Why not C: This choice correctly computes the Year 1 interest but incorrectly amortizes the right-of-use asset over the 10-year economic life. When a finance lease does not transfer ownership and no purchase option is expected to be exercised, the lessee amortizes the ROU asset over the lease term (6 years), not the asset's full economic life.
Why not D: This choice correctly arrives at the combined Year 1 amount (interest plus amortization) but is incorrect in form: a lessee finance lease recognizes interest expense and amortization expense separately in the income statement, not a single combined lease expense.
Question 7
Hint
Separate amounts that create the lease liability from amounts that adjust the initial ROU asset. A payment already made at commencement does not remain unpaid.
Answer C. The initial lease liability is the present value of unpaid lease payments and therefore excludes the $90,000 payment made at commencement, so it equals $240,570. Sales-based variable payments are excluded from initial measurement because they are not based on an index or rate. The initial ROU asset equals the lease liability plus the $90,000 payment made at commencement and the $8,000 initial direct cost, less the $5,000 lease incentive: 240,570 + 90,000 + 8,000 - 5,000 = 333,570.
Why not A: This reflects forgetting to include qualifying initial direct costs in the ROU asset. The liability is correct, but the asset should also include the $8,000 broker commission.
Why not B: Tempting if a student incorrectly includes the commencement payment in the initial liability. Payments made at or before commencement are not part of the unpaid payments used to measure the liability, though they are included in the ROU asset.
Why not D: This result omits the $90,000 commencement payment from the ROU asset. The ROU asset includes the liability plus any lease payments made at or before commencement, plus initial direct costs, less lease incentives.
Question 8
Hint
Separate the items that affect only the lease liability from the additional items that adjust the right-of-use asset at commencement.
Answer B. The lease liability equals the present value of lease payments not yet paid at commencement, which is $360,000. The right-of-use asset equals the lease liability plus lease payments made at or before commencement ($100,000) plus initial direct costs ($8,000) less lease incentives received ($15,000): 360,000 + 100,000 + 8,000 - 15,000 = 453,000. The $6,000 maintenance prepayment is for a separate nonlease service and is excluded; expected usage-based variable amounts are not included in initial lease measurement.
Why not A: This choice correctly identifies the lease liability as $360,000 but omits the $100,000 payment made at commencement from the ROU asset calculation. That payment is included in the initial ROU asset (it was paid at or before commencement).
Why not C: This reflects the common error of including the payment made at commencement in the lease liability. Under ASC 842 the lease liability is the PV of payments not yet paid at commencement (given as $360,000); the $100,000 payment at commencement is excluded from that liability but included in the ROU asset calculation.
Why not D: This overstates the ROU asset by including the $6,000 maintenance prepayment. Because Delta accounts for lease and nonlease components separately and the maintenance is a separate service arrangement, that prepayment is not included in the initial ROU asset.
Question 9
Hint
Start with the PV of unpaid fixed payments (lease liability) and decide which items at commencement increase or decrease the ROU asset: payments at or before commencement, lease incentives, and qualifying initial direct costs.
Answer C. Initial ROU asset = lease liability + payments made at or before commencement - lease incentives received + qualifying initial direct costs. Here: lease liability = $390,000; add the $120,000 commencement payment; subtract the $15,000 cash incentive; add $9,000 initial direct costs. Total = $390,000 + $120,000 - $15,000 + $9,000 = $504,000. The $18,000 maintenance (nonlease) and usage-based variable payments are excluded from initial measurement.
Why not A: This equals $390,000 - $15,000 + $9,000 = $384,000. It's tempting because it adjusts the lease liability for the incentive and initial direct costs, but it incorrectly omits the $120,000 payment made at commencement, which must be included in the ROU asset.
Why not B: This is just the lease liability (PV of the unpaid fixed payments). It tempts by ignoring other required adjustments: the ROU asset also reflects payments made at or before commencement and is adjusted for incentives and qualifying initial direct costs.
Why not D: This equals $390,000 + $120,000 + $9,000 = $519,000. It's tempting because it adds the commencement payment and initial direct costs to the lease liability, but it fails to subtract the $15,000 cash lease incentive, which reduces the initial ROU asset under ASC 842.
Common questions
Do I include the first payment in the lease liability when payments are due at the beginning of the period?
No. Exclude the payment made at commencement from the liability. Add it to the ROU asset as prepaid rent.
What discount rate should I use to present value the payments if the implicit rate is not known?
Use the lessee’s incremental borrowing rate when the implicit rate is not readily determinable.
Are CPI-linked payments included in the lease liability?
Yes. Include index-based amounts using the index in effect at commencement. Exclude sales- or usage-based variable payments.
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