Which rate is typically used by the lessee to calculate the present value of minimum lease payments?

In leasing transactions, the present value of minimum lease payments is primarily calculated using the implicit rate in the lease, if that rate is known. The implicit rate is the discount rate that, when applied to the minimum lease payments and the unguaranteed residual value, equates the present value of these payments to the fair value of the underlying asset at the beginning of the lease term. This approach ensures that the lessee accurately reflects the cost of the lease in line with the terms established by the lessor.

If the implicit rate is not readily determinable, the lessee would then utilize their incremental borrowing rate, which is the rate they would incur to borrow funds over a similar term with similar collateral. This provides a reasonable alternative for estimating the present value of lease obligations. By using either the implicit rate or the incremental borrowing rate, the lessee matches the lease's economic realities with their financing costs.

Using other rates, such as the rate of return on similar investments or the current market interest rate for loans, would not align with the lease's specific terms and may not accurately reflect the economic cost associated with that specific lease agreement. Therefore, the choice of the implicit rate or the incremental borrowing rate is critical for proper financial reporting and aligning with the