JournaldrillFinance lease
At commencement a lessee debits Right-of-Use Asset and credits Lease Liability for the present value of the lease payments. Each payment debits Interest Expense (liability balance times the rate) and Lease Liability (the rest) and credits Cash. The asset is amortized straight-line over the lease term or the asset's life.
Syntax
Commencement: Dr Right-of-Use Asset / Cr Lease Liability (PV of payments); Payment: Dr Interest Expense, Dr Lease Liability / Cr Cash; Amortization: Dr Amortization Expense / Cr Accumulated Amortization, ROU Asset| Part | What it is |
|---|---|
Right-of-Use (ROU) Asset | Lessee's asset for the right to use the leased item; measured at the lease liability plus initial direct costs and prepaid amounts. |
Lease Liability | Present value of remaining lease payments discounted at the rate implicit in the lease or the incremental borrowing rate. |
Interest Expense | Opening liability balance x discount rate for the period. |
Amortization Expense | ROU asset cost divided by the lease term (or useful life if ownership transfers or a purchase option is reasonably certain). |
Examples
Dr Right-of-Use Asset 50,000 / Cr Lease Liability 50,000Result: Assets up 50,000, liabilities up 50,000
5-year equipment lease, annual payments of 12,000 at year end, 6% rate; the present value is taken as 50,000 for this example.
End of year 1: Dr Interest Expense 3,000, Dr Lease Liability 9,000 / Cr Cash 12,000Result: Liability falls to 41,000
Interest 50,000 x 6% = 3,000; principal 12,000 - 3,000 = 9,000.
Dr Amortization Expense 10,000 / Cr Accumulated Amortization, ROU Asset 10,000Result: ROU asset carrying amount 40,000 after year 1
50,000 / 5 years straight-line; no ownership transfer, so the lease term is used.
End of year 2: Dr Interest Expense 2,460, Dr Lease Liability 9,540 / Cr Cash 12,000Result: Liability falls to 31,460
Interest 41,000 x 6% = 2,460; interest falls each year as the liability shrinks.
Common mistakes
- Expensing the full lease payment as rent: for a finance lease the payment is split into interest and reduction of the liability, and the asset is amortized separately.
- Recording the liability at the total of undiscounted payments: the liability is the present value, discounted at the rate in the lease or the incremental borrowing rate.
- Amortizing over the asset's useful life when ownership does not transfer: use the shorter lease term unless title passes or a purchase option is reasonably certain.
Practice Finance lease
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- Finance lease at commencementOn January 1, Summit Freight signs a 5-year lease for a forklift that qualifies as a finance lease. Payments are made at the end of each year, and the present value of the lease payments is $105,309.09. There are no initial direct costs or prepaid payments. Record the lease at commencement.
- First finance lease paymentSummit Freight's finance lease liability is $105,309.09 at January 1, with an implicit interest rate of 6%. On December 31 it makes the first annual payment of $25,000. Record the payment only; amortization of the right-of-use asset is recorded separately.
Questions
What is the difference between a finance lease and an operating lease for a lessee?
Both put an ROU asset and lease liability on the balance sheet under ASC 842. A finance lease shows interest expense plus amortization expense; an operating lease shows a single straight-line lease expense.
How is the lease liability calculated?
The present value of the remaining lease payments, discounted at the rate implicit in the lease or, if unknown, the lessee's incremental borrowing rate.
What is the journal entry for the first lease payment?
Debit Interest Expense for the liability times the rate, debit Lease Liability for the remainder of the payment, and credit Cash.
Related
- Bonds issued at par, discount or premiumHow to record a bond issue: Dr Cash, Cr Bonds Payable at face, with Discount on Bonds Payable (debit) or Premium on Bonds Payable (credit) for the difference.
- Notes payableHow to record a promissory note: Dr Cash, Cr Notes Payable when borrowing; Dr Interest Expense, Cr Interest Payable at period end; repayment at maturity.
- Depreciation entryHow to record depreciation: Dr Depreciation Expense, Cr Accumulated Depreciation. Straight-line formula, monthly and annual examples and book value.
- Accrued interestHow to accrue interest on a note at period end: Dr Interest Expense, Cr Interest Payable (borrower) or Dr Interest Receivable, Cr Interest Revenue (lender).