Question:
What is a lease expense under ASC 842?
Answer:
Under the new ASC 842 lease accounting standard, the lease expense for operating leases is split into two parts:
Amortization of the Right-of-Use (ROU) Asset: This shows how the value of the leased asset decreases over time, similar to how depreciation works for owned assets.
Interest Expense: This is the cost of financing the lease. It's calculated by applying an interest rate to the remaining lease liability.
This replaces the previous method of simply spreading rent evenly over the lease term.
How to calculate the total lease expense under ASC 842:
Step 1: Calculate the Lease Liability
Find the present value of the minimum lease payments (excluding contingent rent, penalties, or residual value guarantees).
If the interest rate is not provided in the lease, use your incremental borrowing rate or the lessor's implicit rate if available.
Step 2: Calculate the Right-of-Use (ROU) Asset
The ROU asset amount will be the same as the present value calculated for the lease liability.
Step 3: Create an Amortization Schedule
Calculate the yearly amortization expense by dividing the ROU asset by the lease term (use straight-line amortization).
Step 4: Calculate Interest Expense
Multiply the lease liability at the start of the period by the interest rate to find the interest expense.
Step 5: Find the Total Lease Expense
Add the amortization expense and the interest expense for that period to get the total lease expense.
Example:
For a 3-year lease with annual rent of $12,000 and an interest rate of 10%:
Lease Liability: Present value of payments (with a discount factor of 2.486) = $33,832
ROU Asset: $33,832
Amortization Expense: $33,832 ÷ 3 years = $11,277 per year
Interest Expense: $33,832 × 10% = $3,383 for the first year
Total Lease Expense for Year 1: $11,277 + $3,383 = $14,660
Repeat similar calculations for years 2 & 3.