How to do lease liability calculations
Under the new lease liability calculation rules, there are a number of assumptions you need to make. These include:
- The lease’s residual value guarantee
- Any rights to exercise options for renewal, termination, or purchase
The residual value guarantee — the estimated fair value of the lease upon termination — and additional options are used as an estimate of probable amounts owed.
Calculating present value of future payments
Using these assumptions, you need to calculate the present value of the minimum future lease payments. The discount rate can be the rate implicit in the lease, which is the rate where lease payments and unguaranteed residual value are equal to the fair value of the asset and its associated costs for the lessor.
If the implicit rate isn’t known, you can use your organization’s incremental borrowing rate (IBR). According to IASB, IBR is the rate that the lessee could realistically borrow the funds necessary for a similar asset under similar terms.
Changes for Periodic Remeasurements for Lease Liabilities
These lease liability calculations will need to be remeasured periodically, as the assumptions you make at the inception of a lease often change over time. Not only might the rate or payment estimates vary, but the lease agreement itself could change due to abandonments, asset impairments, and other modifications.
You’ll likely need to perform these calculations for nearly all of your leases, even if they were previously considered operating leases…
Under the new lease accounting standards, nearly all leases must be brought onto the balance sheet with ROU asset and liability calculations.
What is a Right of Use (ROU) Asset?
For a lessee, a right-of-use or right-to-use lease asset is defined as the lessee’s right to occupy, operate or hold a leased asset legally owned by another party during a specific lease term. The new standards require you to record the actual right-to-use of the asset (i.e. the right to use a cargo truck) rather than the actual asset (i.e. the cargo truck itself). This means that the right-of-use asset is an intangible asset.
How to Calculate ROU for Leases?
The ROU asset is calculated starting from the initial liability of the lease, plus initial direct costs, plus prepaid (or accrued) lease payments, less any lease incentives received.
Written as a formula, this is how to calculate an ROU asset:
Right-of-use (ROU) asset =
Lease liability present value of lease payments not yet paid at that date
+ initial direct costs incurred by lessee
+ or – any lease payments made at or before commencement date
– applicable lease incentives received