The new Lease Accounting Regulations (ASC 842) require organizations that lease assets, or “Lessees” to recognize the assets and liabilities of those leases on their balance sheets. Most leases, including most operating leases, are now capitalized on the balance sheet.
Under finance lease accounting, an asset and a liability are recorded on the balance sheet at the present value of the lease payments, with certain modifications for items such as prepayments and initial direct costs. 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 their incremental borrowing rate at lease commencement. On the income statement, the lease costs are recorded as a straight-line amortization expense plus a declining interest expense.
With TValue software, determining this present value is a simple calculation. By doing a present value calculation, you can determine the value of the lease asset to capitalize on your balance sheet and have the supporting amortization schedule to allocate the principal and interest.
Let’s walk through a case in TValue. The compounding period is based on the cash flows. We will assume monthly cash flows and the interest or discount rate is based on the company’s incremental borrowing rate. The cash flows are inclusive of regular payments/rents and any residuals/balloons.
In our example, we will use Monthly as our Compounding Period and a Nominal Annual Rate, our incremental borrowing rate, of 4%. We will enter a Lease Event on the first cash flow line with the Amount “Unknown”. The second line will be a Lease Payment, starting one month later, with an Amount of $5,000 for a Period of 47 months. The third line will be a Residual with an Amount of $15,000. This would aggregate to $250,000 in cash flows. The present value or the capitalized value of the operating lease would be $229,968. Here is the setup in TValue.
Although the calculations in TValue can often be straight forward, there can be numerous factors to consider. The Accounting Standards Codification 842, Leases is 511 pages and covers too many issues to discuss in this blog.
TimeValue Software has more information on lease calculations at TValue Leasing and has two recorded webinars on basic and advanced lease pricing that you can view from our Archives at TValue Leasing Webinars.
If you have any questions using TValue software, please give our Support Team a call at 800-426-4741 or shoot us an email at support@TimeValue.com