On January 1, 2019, Lessee entered into the Lease Agreement to immediately lease 100,000 square feet of space for a period of 10 years of office space from Lessor, beginning on January 1, 2019. Lease payments based on $8 per square foot per month are due at the beginning of each month. The lease is an industrial gross lease, meaning that the fixed lease payment includes the lessee's share of insurance, maintenance, taxes and common area expenses. Lessee has concluded that of the monthly payments, 80% relate to the leased space, 8% for common areas, 5% for taxes, 3% for insurance, and 4% for maintenance. Lessee has immediate access to the leased space on January 1, 2019. Lessee concludes that its incremental borrowing rate is 5% and that 5% is an appropriate discount rate to estimate both the fair value of the lease and nonelease elements under a discounted cash flow basis.

Additionally, the Lease Agreement provides for the Lessor to reimburse the up to $5 million of Lessee's tenant improvements. Lessee has concluded that it is the accounting owner of these improvements. Lessee begins construction of the improvements on February 1, 2019, and completes the improvements on May 31, 2019 at a cost of $8 million. Lessee then moves into the space on June 1, 2019. Lessor pays Lessee the $5 million allowance on June 30, 2019.

Assume that Lessee has concluded that the lease is an operating lease.

Question 1: At inception of the lease, determine the lease payments and the amount of lease liability under the Lease Agreement.

Question 2: Determine how Lessee should record the lease incentive when it receives it on June 30, 2019. See EY FRD 2.4.1.2 for additional details on treatment of incentive payments. However, simply following the simple model that EY provides may not be the correct solution for this case. Please consider the incentive payment as contra-consideration, which is no different than any other form of consideration under a lease agreement.