In last week’s post, we discussed how ASC 842 Leases will be effective for private companies beginning next year. This means that lessees will be required to record nearly all leases on the balance sheet by crediting a lease liability, with a corresponding debit to the right-of-use (ROU) asset. The lease liability is the present value of the remaining lease payments. To determine this amount, you need three critical inputs:
- Lease term
- Lease payments
Lucky for you, we’ve created videos explaining each one! And they’re absolutely free!
First, we need figure out the lease term. According to ASC 842, the lease term is the noncancellable period for which a lessee has the right to use an underlying asset, together with all of the following:
- Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option,
- Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option, or
- Periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor.
Obviously, the noncancellable period is pretty straightforward, but options can get a bit tricky, especially the judgment surrounding whether or not it is “reasonably certain.” Check out the video or this post to learn more.
Once we’ve determined the lease term, we need to figure out the lease payments over that time period. Lease payments are determined at the commencement date and consist of:
- Fixed payments, including in substance fixed payments, less any incentives paid or payable to the lessee.
- Variable lease payments that depend on an index or rate (e.g., CPI), initially measured using the index or rate at the commencement date.
- The exercise price of an option to purchase the underlying asset if the lessee is reasonably certain to exercise that option.
- Payments for penalties for terminating the lease if the lease term reflects the lessee exercising an option to terminate the lease.
- Fees paid by the lessee to owners of a special-purpose entity for structuring the transaction.
- Amounts probable of being owned by the lessee under residual value guarantees (lessees only).
Finally, we need the applicable discount rate to discount the lease payments back to the lease commencement date. For a lessee, the discount rate for the lease is the rate implicit in the lease unless that rate cannot be readily determined. In that case, the lessee is required to use its incremental borrowing rate. For a lessor, the discount rate for the lease is the rate implicit in the leases.
Want to learn more about accounting for leases under U.S. GAAP (ASC 842) and IFRS (IFRS 16), check out our Leases topic page. And if you need training on ASC 842, be sure to check out our ASC 842 Leases collection, a collection of four, online eLearning course totaling 6 CPE credits. It’s available for immediate purchase and viewing to get you started with your training today!
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