Corporate Financial Reporting · Leases (Ind AS 116)

Lease Term, Lease Payments and Discount Rate under Ind AS 116

Updated 11 October 2026 · Fact-checked

Under Ind AS 116, a lessee measures the lease liability at the present value of unpaid lease payments over the lease term. The lease term includes extension options it is reasonably certain to use. Discount at the rate implicit in the lease if readily determinable; otherwise use the incremental borrowing rate.

Understand Lease Term, Lease Payments and Discount Rate

A lessee's lease liability depends on three inputs: how long the lease runs, which payments count, and the rate used to discount them. Get these three right and the rest is arithmetic.

Lease term is the non-cancellable period, plus periods covered by extension options the lessee is reasonably certain to exercise, plus periods covered by termination options the lessee is reasonably certain not to exercise. Think about economics. A big leasehold improvement, a critical location or a high termination penalty makes an extension more likely. The standard says the lessee reassesses the term when it changes (paragraphs 20-21 are the reference for this assessment).

Lease payments are payments for the right to use the asset during the lease term. They comprise: fixed payments (including in-substance fixed payments) less lease incentives; variable payments that depend on an index or a rate; the exercise price of a purchase option if the lessee is reasonably certain to exercise it; and penalties for terminating, if the term reflects the lessee terminating. For a lessee they also include amounts expected to be payable under residual value guarantees. Payments allocated to non-lease components are excluded, unless the lessee elects to combine them with the lease component.

Variable lease payments that depend on something else, such as a percentage of sales or usage, are not in the liability. They are expensed when incurred. Only index or rate-linked payments are included, initially measured using the index or rate at the commencement date.

Discount rate: under paragraph 26, use the interest rate implicit in the lease if it can be readily determined. If not, use the lessee's incremental borrowing rate (IBR). The implicit rate is the rate that makes the present value of lease payments plus the unguaranteed residual value equal the fair value of the asset plus the lessor's initial direct costs. The IBR is the rate the lessee would pay to borrow, over a similar term and with similar security, the funds needed to obtain an asset of similar value to the right-of-use asset in a similar economic environment. In practice, lessees usually do not know the lessor's residual value or costs, so the IBR is often used.

Key rules to remember

Lease term: Non-cancellable period + extension periods reasonably certain to be used + periods after termination options reasonably certain not to be exercised; Reasonable certainty is a judgement based on economic incentives.
Lease liability at commencement: Σ [Unpaid lease payment ÷ (1 + r)^t]; r is the implicit rate if readily determinable, else the IBR (paragraph 26).
Lease payments included: Fixed (less incentives) + index/rate-linked variable + purchase option price if reasonably certain + termination penalties if the term reflects termination + expected residual value guarantee amounts; Sales-based or usage-based variable payments and non-lease components are excluded.
Interest rate implicit in the lease: PV of (lease payments + unguaranteed residual value) = Fair value of asset + lessor's initial direct costs; Solve for the rate r.
Revised discount rate on remeasurement: Implicit rate for the remainder of the term if readily determinable; else IBR at the reassessment date; Applies to a change in term or purchase option assessment (paragraphs 40-41). For modifications, the date is the effective date (paragraph 45).
Remeasurement with the original rate: Change in residual value guarantee or index/rate-linked payments: remeasure by discounting revised payments; Paragraph 42. The index change is reflected only when the cash flows change.

How to solve Lease Term, Lease Payments and Discount Rate questions

Work in this order for any question on term, payments and rate.

1Identify the non-cancellable period from the contract.
2Assess each extension and termination option. Include only those where the lessee is reasonably certain to extend, or reasonably certain not to terminate. Use the facts given: improvements, penalties, importance of the asset.
3List each payment and classify it: fixed, index-linked, variable on usage or sales, purchase option, penalty, residual value guarantee, non-lease component.
4Drop the excluded items: sales or usage-based payments, non-lease components (unless combined), and payments already made at the commencement date.
5Choose the rate: implicit rate if it can be readily determined, otherwise IBR. Check that the IBR matches the term, security and asset value.
6Discount the payments, noting whether they fall at the start or end of each period, and arrive at the lease liability.
7If the question gives a later event, identify which paragraph applies, decide whether the rate is revised, and remeasure.

Quickest way: Four-question screen

When to use it: Use this on MCQs and on the first minutes of a numerical question.

Term: is the lessee reasonably certain about the option? If yes, include the period.
Payment: is it fixed or tied to an index or rate? If it depends on sales or usage, leave it out.
Rate: is the implicit rate given or readily determinable? If not, take the IBR.
Remeasurement: a change in term or purchase option assessment needs a revised rate; a change in a residual value guarantee or an index does not (paragraphs 40 and 42 refer to the revised payments only).

Common mistakes in Lease Term, Lease Payments and Discount Rate

Including sales-based rent in the lease liability.
Students treat every payment to the lessor as a lease payment.
Fix: Only fixed and index or rate-linked payments are included. Other variable payments go to profit or loss when incurred.
Extending the lease term simply because an option exists.
Students see the option and assume it will be used.
Fix: Include the option period only if the lessee is reasonably certain to exercise it. Look for incentives such as improvements, penalties or the asset's importance.
Using the incremental borrowing rate when the implicit rate is given.
The IBR feels more familiar.
Fix: Under paragraph 26 the implicit rate comes first if it can be readily determined.
Discounting payments already made at commencement.
Students take the total of all payments in the contract.
Fix: The liability is the present value of payments not paid at the commencement date. An advance payment goes into the right-of-use asset cost.
Using a revised discount rate for a change in a residual value guarantee.
Students assume every remeasurement needs a new rate.
Fix: Paragraphs 40 and 41 call for a revised rate when the term or purchase option assessment changes. Paragraph 42 covers guarantees and index changes, which use the revised payments.
Excluding the expected residual value guarantee amount from the lessee's lease payments.
Students confuse it with the lessor's treatment, where the full guarantee is included.
Fix: For the lessee, include only the amount expected to be payable under the guarantee.

Worked examples

Example 1

Sundaram Textiles Ltd leases a machine from Kaveri Leasing for a non-cancellable 3 years from 1 April 2026. Annual rent is ₹2,00,000, payable at the end of each year. There is an option to extend for 2 more years at ₹2,50,000 a year, which the company is not reasonably certain to exercise. Additional rent of 1% of sales is payable. The rate implicit in the lease cannot be readily determined; the IBR is 10%. Compute the lease liability at commencement. Discount factors at 10%: year 1 0.9091, year 2 0.8264, year 3 0.7513.

Show the solution

Lease term: only the 3 non-cancellable years count, because the extension is not reasonably certain.
Lease payments: fixed rent of ₹2,00,000 a year for 3 years. The 1% of sales rent is variable and not index-linked, so it is excluded.
Rate: the implicit rate is not readily determinable, so use the IBR of 10%.
Sum of discount factors = 0.9091 + 0.8264 + 0.7513 = 2.4868.
Lease liability = ₹2,00,000 × 2.4868 = ₹4,97,360.

Answer: Lease liability at 1 April 2026 is ₹4,97,360. The sales-based rent is expensed as incurred.

Example 2

Ganga Retail Ltd leases a showroom for 4 years with payments of ₹5,00,000 at the end of each year. It also pays ₹40,000 a year for maintenance services, which is a separate non-lease component, and the company has not elected to combine it. Ganga has guaranteed to the lessor that the residual value of the fittings will be at least ₹3,00,000; the company expects to pay ₹50,000 under that guarantee at the end of year 4. IBR is 10%. Discount factor for year 4 is 0.6830 and annuity factor for 4 years is 3.1699. Compute the lease liability.

Show the solution

Fixed lease payments: ₹5,00,000 a year for 4 years. The maintenance charge of ₹40,000 is a non-lease component and is excluded.
Residual value guarantee: include the amount expected to be payable, ₹50,000 at the end of year 4. The full ₹3,00,000 is not included.
PV of rent = ₹5,00,000 × 3.1699 = ₹15,84,950.
PV of guarantee = ₹50,000 × 0.6830 = ₹34,150.
Lease liability = ₹15,84,950 + ₹34,150 = ₹16,19,100.

Answer: Lease liability is ₹16,19,100, using the IBR because no implicit rate is given.

Exam tips

In MCQs, watch for the words 'reasonably certain'. Facts about penalties, improvements or business importance usually signal the intended answer on term.
Write a short classification list of payments (included or excluded, with a reason). It earns marks even if your arithmetic slips.
State which rate you use and why. A line saying the implicit rate cannot be readily determined, so the IBR is used, is worth including.
For remeasurement questions, cite the trigger. A change in term needs a revised rate. A change in a residual value guarantee or an index does not.
Read the timing of payments carefully. Advance versus arrears changes the discount factors.

Practice questions from Leases (Ind AS 116)

Lease Term, Lease Payments and Discount Rate in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CA FinalScope, Definition of a Lease and Identifying a Lease

Lease Term, Lease Payments and Discount Rate: frequently asked questions

How do I decide whether an extension option is included in the lease term?

Include it only if the lessee is reasonably certain to exercise it. Look at economic incentives such as significant leasehold improvements, high costs of replacing the asset, or favourable option rates. An option the lessee merely might use is left out.

What is the difference between the implicit rate and the incremental borrowing rate?

The implicit rate equates the present value of lease payments and unguaranteed residual value to the asset's fair value plus the lessor's initial direct costs. The IBR is what the lessee would pay to borrow, on a similar term and security, to buy an asset like the right-of-use asset. The implicit rate is used first when it can be readily determined.

Are variable lease payments part of the lease liability?

Only variable payments that depend on an index or a rate are included, measured at the commencement date index or rate. Payments based on sales or usage are excluded and recognised as expense when incurred.

Does a residual value guarantee always increase the lease liability?

For a lessee, the liability includes only the amount expected to be payable under the guarantee. If no payment is expected, nothing is added. If the expected amount changes later, the lessee remeasures the liability using the revised payments.