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How do you calculate the right-of-use asset and lease liability under new standards?

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If you are involved in commercial leasing, you may have heard of the new lease accounting and reporting standards that affect how you recognize and measure leases on your balance sheet. These standards, issued by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), require lessees to record most leases as right-of-use assets and lease liabilities, rather than operating expenses. But how do you calculate these amounts and what factors do you need to consider? In this article, we will explain the basic steps and formulas for determining the right-of-use asset and lease liability under the new standards.

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1 Lease classification

The first step is to classify the lease as either a finance lease or an operating lease, based on the criteria set by the IASB or the FASB, depending on your jurisdiction. A finance lease transfers substantially all the risks and rewards of ownership of the underlying asset to the lessee, while an operating lease does not. The classification affects how you amortize the right-of-use asset and the lease liability over the lease term, as well as how you present them in your financial statements.

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The proffesor Freelance Writer

Senior freelance writer YouTube; Tess Temurr @tesstemurr5013)
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?? Calculating the right-of-use asset and lease liability under new standards, specifically ASC 842 and IFRS 16, involves a two-step process: Step 1: Calculate the initial lease liability. This represents the present value of all future lease payments discounted at the lessee's incremental borrowing rate. It encompasses: Regular lease payments: Fixed or variable amounts payable over the lease term. Guaranteed residual value: The amount the lessee is obligated to pay for the asset at the end of the lease, if applicable. Bargain purchase option: If the lessee has the option to purchase the asset at a price below its fair value at the end of the lease, this is included. Initial direct costs:

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Abbas Hashmi ABFP?

Chief Strategy Officer | Cap Raising Accelerant | Ex-Goldman Sachs | Family Office & RIAs | Led Global Community of HNW Households, Global Family Offices & NextGen | Keynote Speaker
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Calculating the right-of-use asset and lease liability under new standards involves a structured approach. Start by identifying lease components and gathering lease terms, including payment details and options. Use the present value of lease payments to determine the initial lease liability. Recognize any initial direct costs and incentives. For the right-of-use asset, consider the lease liability, any prepaid or accrued lease payments, and initial direct costs. Amortize both the asset and liability over the lease term, accounting for variable lease payments and reassessing if there are significant lease modifications. Regularly reassess assumptions for accuracy.

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2 Lease payments

The next step is to identify the lease payments that you need to include in the calculation of the right-of-use asset and the lease liability. These are the payments that you are obliged to make under the lease contract, such as fixed rent, variable rent based on an index or a rate, lease incentives, residual value guarantees, and termination penalties. You should exclude payments that are not related to the right to use the underlying asset, such as service charges, maintenance costs, or taxes.

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The proffesor Freelance Writer

Senior freelance writer YouTube; Tess Temurr @tesstemurr5013)
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Step 2: Calculate the right-of-use asset. This represents the lessee's right to use the leased asset over the lease term. It's generally equal to the initial lease liability plus any up-front payments made before the lease commencement date, minus any lease incentives received. Here's the formula: Right-of-use asset = Initial lease liability + Up-front payments - Lease incentives

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3 Discount rate

The third step is to determine the discount rate that you will use to discount the lease payments to their present value. This is the rate that reflects the interest rate implicit in the lease, if it is readily determinable, or your incremental borrowing rate, if it is not. The interest rate implicit in the lease is the rate that makes the present value of the lease payments and the residual value equal to the fair value of the underlying asset. The incremental borrowing rate is the rate that you would have to pay to borrow the funds necessary to obtain an asset of similar value and term.

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The proffesor Freelance Writer

Senior freelance writer YouTube; Tess Temurr @tesstemurr5013)
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Remember that both the right-of-use asset and lease liability are amortized over the lease term on a straight-line basis. The amortization expense reduces both the asset and the liability each period. Here are some additional points to note: Short-term leases (less than 12 months) are exempt from these calculations. ASC 842 and IFRS 16 have slight differences in their treatment of certain lease components. Be sure to consult the relevant standard for specific guidance. Software as a service (SaaS) arrangements typically fall under operating leases and require ROU asset and lease liability recognition. I hope this clarifies the calculation process!

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4 Lease liability

The fourth step is to calculate the lease liability by discounting the lease payments using the discount rate. The lease liability represents your obligation to make lease payments over the lease term. You should update the lease liability for any changes in the lease payments, the discount rate, or the lease term that occur after the commencement date of the lease.

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5 Right-of-use asset

The fifth step is to calculate the right-of-use asset by adding any initial direct costs and lease incentives to the lease liability, and subtracting any prepaid rent. The right-of-use asset represents your right to use the underlying asset over the lease term. You should depreciate the right-of-use asset on a straight-line basis for operating leases, or on a systematic basis that reflects the pattern of consumption of the underlying asset for finance leases.

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6 Lease accounting

The final step is to account for the right-of-use asset and the lease liability in your financial statements. For operating leases, you should recognize the right-of-use asset and the lease liability as separate line items on your balance sheet, and recognize the depreciation expense and the interest expense on the lease liability in your income statement. For finance leases, you should present the right-of-use asset within the same category as the underlying asset, and present the lease liability within the same category as your other borrowings, on your balance sheet. You should also recognize the depreciation expense and the interest expense on the lease liability in your income statement.

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How do you calculate the right-of-use asset and lease liability under new standards?

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3

4

5

6

7

1 Lease classification

2 Lease payments

3 Discount rate

4 Lease liability

5 Right-of-use asset

6 Lease accounting

7 Here’s what else to consider

Commercial Leasing

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How do you calculate the right-of-use asset and lease liability under new standards?

1

2

3

4

5

6

7

1 Lease classification

2 Lease payments

3 Discount rate

4 Lease liability

5 Right-of-use asset

6 Lease accounting

7 Here’s what else to consider

Commercial Leasing

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