Also called “Rate Implicit in the Lease”
“The rate of interest that, at a given date, causes the aggregate present value of (a) the lease payments and (b) the amount that a lessor expects to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the lessor and (2) any deferred initial direct costs of the lessor.” [842-10-20]
If the Lessor’s initial direct costs are unknown to the Lessee, no implicit rate is calculated. Clause (b) above includes both guaranteed and unguaranteed residual values.
For a Lessor calculating the implicit rate to perform the present value test for lease classification, initial direct costs are assumed not to be deferred if the fair value is different from the carrying amount. However, once classification is determined, the implicit rate is recalculated based on whether or not the initial direct costs are actually deferred (see initial direct costs for those rules).