Lease liability calculation is one of the more challenging and demanding tasks in the world of accounting. Depending on your accounting standard, streamlining and optimizing calculation, according to requirements can become a burden. This is why we’d like to make a guide for accountants which could in short, overlook the management of data, related even to operating lease liabilities and calculation of any other lease liabilities. Without any further ado, let’s begin!
How lease liability calculation changed after new accounting standard implementation
As we all know very well, ASC842, IFRS16 and AASB16 are the latest according standards, according to which, every company’s financial records must now be compliant with. Transitioning is never easy, but when it comes to bookkeeping and very demanding data like lease liability, it just gets even more challenging.
With the new standard, liability needs to be calculated on a frequent basis. Asset impairments and things like abandonments could cause changes to the contract and liability figures which means that remeasurement will be necessary. The companies are now required to transpose lease information and data onto the balance sheet. Two figures are mentioned and one of them is lease liability calculation. The other one is known as ROA for short (Right-of-use-asset). Calculating ROA isn’t all that difficult.
ROA = Initial Direct Costs + Prepayments – Lease Incentives
By subtracting the amount of lease incentives from the sum of initial direct costs and prepayments, you can see the ROA figure which is used for lease liability calculation.
Lease liability calculation – how it’s done
Even for veteran accountants, lease liability calculation is never something that’s easy to do. In general, there is a simple set of rules that allows your staff to measure any lease liability. It has to be calculated by combining assumptions of the total residual guaranteed value (of the lease) and the rights to exercise renewal, purchasing, termination or additional options.
Moving on with lease liabilities accounting, now comes calculation of current value of upcoming payments. With the two above-mentioned assumption-based calculations, you need to measure how much value do minimum lease payments future have in the present. This means finding out the implicit (also known as discount) rate and applying it. If you can’t find the implicit rate, use your IBR (incremental borrowing rate) as a substitute.
How these calculations help businesses
In general, the changes of accounting standards and new lease liability calculation rules mean that balance sheets will be inflated because of the reduced liabilities and the addition of future payments to their dedicated tabs.
Even if these calculations are hard to do and overlook, they’re crucial for the business. By inflating the balance sheet, these calculations can be the primary reason for a higher valuation of the company which can result in more lucrative deals with investors, etc.
The trickiest part is applying recalculation for every contract that you have. Appropriate adjustments have to be made periodically which is a bit of a burden, but totally worth it!