Implicit Interest Rate is defined as

Implicit Interest Rate is defined as

• A. The discount rate that, when applied to the minimum lease payments, causes the aggregate present value at the beginning of the lease term to equal the fair value of the leased property to the lessor at the inception of the lease.
• B. The discount rate that is explicitly stated in the lease agreement.
• C. The rate a lessee would pay to borrow funds to purchase the asset.
• D. The rate used to calculate executory costs.

Answer: (A)

Implicit interest rate is the discount rate that, when applied to the minimum lease payments, makes the present value of those payments equal the fair value of the leased asset at the lease’s inception. It’s the rate of return embedded in the lease that the lessor earns. If this rate is known, the lessee uses it to measure the lease liability and the right-of-use asset; if it isn’t known, the lessee uses the incremental borrowing rate. The other options describe different concepts: the stated lease rate isn’t necessarily the implicit rate; the rate to borrow to buy the asset is the incremental borrowing rate; and executory costs aren’t tied to calculating the lease’s present value.

Implicit interest rate is the discount rate that, when applied to the minimum lease payments, makes the present value of those payments equal the fair value of the leased asset at the lease’s inception. It’s the rate of return embedded in the lease that the lessor earns. If this rate is known, the lessee uses it to measure the lease liability and the right-of-use asset; if it isn’t known, the lessee uses the incremental borrowing rate. The other options describe different concepts: the stated lease rate isn’t necessarily the implicit rate; the rate to borrow to buy the asset is the incremental borrowing rate; and executory costs aren’t tied to calculating the lease’s present value.