Which statement correctly defines the Implicit Interest Rate?

• A. The rate used to evaluate the lease for tax purposes.
• B. The rate that, when applied to minimum lease payments, yields the present value equal to the fair value of the asset at inception.
• C. The rate the lessee would borrow to purchase the asset under like terms.
• D. The rate used to discount executory costs.

Answer: (B)

The implicit interest rate is the rate that, when applied to the minimum lease payments, produces a present value equal to the fair value of the asset at the start of the lease. This rate is effectively the rate the lessor charges for the lease. It’s the rate used to discount the lease payments to measure the lease liability and to recognize the right-of-use asset. If this rate can’t be readily determined, the lessee uses its incremental borrowing rate instead. Executory costs are treated differently and aren’t discounted at the implicit rate.