1. Scenario Technical Specifications
A corporation enters into a non-cancellable 4-year equipment lease on 1 January 2026.
  • Annual lease payments: $50,000 due in advance on 1 January each year.
  • The interest rate implicit in the lease is not readily determinable.
  • The lessee’s incremental borrowing rate (IBR) is 10% per annum.
  • The lease contains no residual value guarantees or renewal options.

2. Present Value Allocation Mechanics
Because the first payment of $50,000 occurs immediately on 1 January 2026, it is not discounted. The remaining three payments of $50,000 occur on 1 January 2027, 2028, and 2029.
\(\text{Present\ Value\ of\ Payments}=\$50,000+\frac{\$50,000}{(1+0.10)^{1}}+\frac{\$50,000}{(1+0.10)^{2}}+\frac{\$50,000}{(1+0.10)^{3}}\)
\(\text{Present\ Value\ of\ Payments}=\$50,000+\$45,454.55+\$41,322.31+\$37,565.74=\$174,342.60\)
  • Initial Commencement Entry (1 January 2026):
    • Debit: ROU Asset = $174,342.60
    • Credit: Lease Liability = $174,342.60

  • Immediate Payment Entry (1 January 2026):
    • Debit: Lease Liability = $50,000.00
    • Credit: Cash = $50,000.00
    • Remaining Net Liability Balance on 1 January 2026: $124,342.60

3. Subsequent Amortization and Interest Accrual Schedule
At the end of Year 1 (31 December 2026), the lessee must accrue interest on the outstanding liability balance and calculate depreciation on the ROU asset:
  • Interest Expense Accrual:

    • Interest Expense = 124342.60 × 10% = 12434.26
    • Debit: Interest Expense = $12,434.26
    • Credit: Lease Liability = $12,434.26

  • Depreciation Expense Accrual:

    • Depreciation Expense = Initial ROU Asset Value / Lease Term = 174342.60 / 4 Years = 43585.65
    • Debit: Depreciation Expense = $43,585.65
    • Credit: Accumulated Depreciation (ROU Asset) = $43,585.65

 
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