How Lease Liability on Terminated Leases Is Calculated
When you terminate a lease, the Generate Schedules process automatically updates the lease liability to be retired based on your settings.
Period End Liability Options
The Generate Schedules process calculates the change in lease liability due to termination based on the Period End Liability option.
|
Period End Liability Option Setting |
Description |
|---|---|
|
Yes |
Termination is effective at the end of the period. |
|
No |
Termination is effective at the start of the period. |
Calculation of Lease Liability on Terminated Leases
The lease liability to be retired is calculated as follows:
-
Period End Liability is set to Yes:
Current liability at the start of the period, minus the principal reduction for payments with an interest due date in the current period, minus the increase in the termination penalty.
-
Period End Liability is set to No:
Current liability at the start of the period minus the termination penalty, if any, with the interest due date in the current period.
The gain or loss on termination calculated as follows:
-
Cost minus depreciation reserve minus impairment reserve, if any, minus the lease liability to be retired.
When you post the termination transaction, a retirement transaction is created for each associated asset. This table shows sample accounting entries for the retirement transaction:
|
Account |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Depreciation Reserve |
800 |
|
|
Impairment Reserve |
200 |
|
|
Lease Liability |
1,100 |
|
|
Asset Cost |
2,000 |
|
|
Gain on Leased Asset |
100 |
Example:
Your company enters into a six-year lease of equipment with annual lease payments of $59,000, payable at the end of each year. Your company classifies the lease as a finance lease. At the end of Year 5, you have the option to terminate the lease for $5,000. You decide that your company has a significant economic incentive to exercise the termination option.
The rate that the lessor charges your company is the rate implicit in the lease, which is 6.33 percent. You measure the lease liability at the commencement date at $250,000 (the present value of five payments of $59,000 plus the present value of the termination option payment of $5,000).
At the lease commencement date, you recognize lease assets and liabilities as shown in this table:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Right-of-Use Asset |
250,000 |
|
|
Lease Liability |
250,000 |
Finance Lease:
Your company amortizes the right-of-use asset over the lease term of five years. You expect your company to consume the asset's future economic benefits evenly over the five years and you amortize the asset on a straight-line basis.
During the first year of the lease, you recognize interest on the lease liability and amortization of the right-of-use asset as follows:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Interest Expense |
15,825 (6.33% x 250,000) |
|
|
Lease Liability |
15,825 |
|
|
Depreciation Expense |
50,000 (250,000 / 5) |
|
|
Depreciation Reserve |
50,000 |
At the end of Year 1, the right-of-use asset is $200,000 ($250,000 - $50,000) and the lease liability is $206,825 ($250,000 + $15,825 - $59,000).
At the end of Year 5, the right-of-use asset is amortized to $0 ($250,000 - $50,000 x 5) and has a liability of $60,190 relating to the last lease payment and termination penalty.
You terminate the lease with the Period End Liability option set to Yes and make the final lease payment. Because the termination occurs at the end of the lease term, there is no gain or loss on this transaction.
Year 5:
This table shows the accounting entry for interest on liability:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Lease Interest Expense |
3,810 (interest amount) |
|
|
Lease Liability |
3,810 |
|
|
Lease Liability |
64,000 (lease payment) |
|
|
Lease Clearing |
64,000 |
This table shows the retirement accounting entry:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Depreciation Reserve |
250,000 |
|
|
Right-of-Use Asset |
250,000 |
This table shows the lease invoice accounting entry:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Lease Clearing |
64,000 |
|
|
Supplier Liability |
64,000 |
This table shows the lease invoice payment accounting entry:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Supplier Liability |
64,000 |
|
|
Bank |
64,000 |
If the termination penalty is $6,000, then the increase or decrease in liability is first calculated and then reflected in the accounting entries.
In year 5, the lease liability to be retired is calculated as the current liability at the start of the period ($60,190), minus the principal reduction for current period payments ($60,190), plus the increase in the termination penalty ($1,000).
In this example, the increase or decrease in liability is 1,000.
This table shows the accounting entry for interest on liability:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Lease Interest Expense |
3,810 (interest amount) |
|
|
Lease Liability |
3,810 |
|
|
Lease Liability |
65,000 (lease payment amount + increase or decrease in liability) |
|
|
Lease Clearing |
65,000 |
This table shows the retirement accounting entry:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Depreciation Reserve |
250,000 |
|
|
Right-of-Use Asset |
250,000 |
|
|
Lease Liability |
1,000 |
|
|
Gain or Loss |
1,000 (increase or decrease in liability) |
This table shows the lease invoice accounting entry:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Lease Clearing |
65,000 |
|
|
Supplier Liability |
65,000 |
This table shows the lease invoice payment accounting entry:
|
Accounts |
Debit Amount (USD) |
Credit Amount (USD) |
|---|---|---|
|
Supplier Liability |
65,000 |
|
|
Bank |
65,000 |