Definition
The lease liability is the present value of lease payments not yet paid, discounted at the rate implicit in the lease when readily determinable, otherwise the lessee's incremental borrowing rate (or a risk-free rate, for lessees that are not public business entities and elect it by class of underlying asset). Payments include fixed payments, in-substance fixed payments, variable payments that depend on an index or rate (measured at commencement), amounts probable of being owed under residual value guarantees, purchase option prices when exercise is reasonably certain, and termination penalties when the term reflects termination.
Why it matters in an audit or review
Auditors recompute the liability, verify payment schedules to contracts, and check the lease term assessment. Remeasurement is required after a modification not accounted for as a separate contract, a change in the lease term, a change in the purchase option assessment, or a change in amounts probable of being owed under residual value guarantees. Current and noncurrent portions must be split.
Example
(Illustrative) A finance lease starts with a lease liability of $252,700, discounted at 6%. Year-one interest is $252,700 x 6% = $15,162. After a $60,000 year-end payment, the liability is $252,700 + $15,162 - $60,000 = $207,862.
Dr Interest expense 15,162 Dr Lease liability 44,838 Cr Cash 60,000
Common mistakes
- Including variable payments tied to usage in the liability.
- Not remeasuring after a term change.
Sources
- FASB ASC 842-20-30-1 through 30-5 (initial measurement of the lease liability and discount rate)
- FASB ASC 842-10-30-5 and 30-6 (lease payments included and excluded)
- FASB ASC 842-20-35-1 through 35-5 (subsequent measurement and remeasurement)
- AICPA, AU-C Section 540, Auditing Accounting Estimates and Related Disclosures
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error