Finance Leases: Present Value, Depreciation and Liabilities for IAS 17

Present Value

Let’s take a closer look now at how to calculate the present value of the minimum lease payments.

The asset and liability to be recognised is the lower of the fair value of the leased asset and the present value of minimum lease payments.

By fair value, we mean the amount, which an asset could be sold or a liability transferred between knowledgeable, willing parties in an arm’s length transaction.

The calculation of fair value using IFRS 13 – Fair Value Measurement does not apply to leases.

When calculating the present value of minimum lease payments, the discount rate to use is:

  • The rate implicit in the lease, if this is possible to calculate, or
  • The incremental borrowing rate for the lessee

Implicit Rate

The interest rate implicit in the lease is the discount rate that:

at the start of the lease,
results in the minimum lease payments plus
any unguaranteed residual value,
to equal
the sum of the fair value of the lease and
any initial direct costs of the lessor.

Incremental borrowing rate

The incremental borrowing rate may be used if it’s not possible to determine the interest rate implicit in the lease.

This is the amount of interest the entity would have to pay if it were to borrow money to purchase the asset.


Once the leased asset and lease liability has been recognised in the financial statement, it should be depreciated over the period the entity will be using the asset.

This is the lower of:

  • Its expected useful life, and
  • The term of the lease

If it’s reasonably certain the entity will obtain ownership of the asset at the end of the lease period, the asset should be depreciated over its expected useful life.

The leased asset will be included in the statement of financial position at its cost, less any accumulated depreciation.

The depreciation will be charged as an expense in the profit or loss.

The journal entries for depreciation are:

DR Depreciation Expense                        XX
CR    Accumulated Depreciaton XX

Keep in mind the depreciation method should also be consistent with the depreciation for the entity’s owned assets.


If a leased asset is impaired, the terms of IAS 36 – Impairment will apply.

Lease Liability

As you would expect, as the lessee makes lease payments, the amount of the lease liability will decrease.

There will be a difference between the amount of the minimum lease payments and the initial liability recorded by the lessee, and this will represent the interest element.

As the lessee makes the lease payments (or rental payments) the payment will be made up of both a repayment of the principal (the lease liability), and an interest cost (finance charge).

This finance charge will be treated as a cost of finance in the income statement.

The repayment of the principal will reduce the unpaid lease liability.

When we’re looking at the lease payments, we’ll have to split out the principal and interest charge.

The interest must be charged in such a way that a constant period rate of interest applies to the unpaid lease liability.

As the payments are made, the journal entries will be:

DR Finance lease liability                           XX
DR Interest Expense XX
CR    Bank XX