How should lease incentives be accounted for in the lessee's financial statements?

• A. Record as part of the right-of-use asset or as a lease incentive, amortized over the lease term; disclose the effect on lease cost.
• B. Recognize as immediate rental expense in the period of signing.
• C. Capitalize but amortize over 50 years regardless of lease term.
• D. Do not recognize any lease incentives.

Answer: (D)

Lease incentives are not ignored or expensed upfront. They affect the measurement of the lease itself. When a lessee signs a lease and the lessor provides incentives (such as rent-free periods or cash payments), those incentives reduce the cost the lessee ultimately bears for the lease. This means the incentive is incorporated into the initial measurement of the right-of-use asset and the lease liability.

At the start, you recognize a right-of-use asset and a lease liability for the lease. The lease liability is the present value of the lease payments, but the incentive reduces that amount, so the initial lease liability is lower. The right-of-use asset is measured at the same amount as the lease liability, adjusted for any prepaid amounts, initial direct costs, and the incentive received (the incentive reduces the asset as well). Over time, you amortize the right-of-use asset over the lease term, while the lease liability accrues interest and is reduced by lease payments. The impact of the incentive is reflected in lower lease costs over the term, and you would disclose how the incentive affects the lease cost.