Accounting for Operating Lease under new Lease Standard

Under the new Lease Standard, which is effective since year 2022, any operating lease with term greater than 12 months must be capitalized and recorded in balance sheet as Right-of-Use Asset and Lease Liability. After that, the Right-of-Use Asset will be amortized on a straight-line basis over the term of the lease. If a business has several operating leases, it will have to monitor and amortize each lease separately.

The following example will demonstrate how to account for operating lease. Followings are some basic knowledge about calculating the lease.

• Lease Liability = Present value of all future lease payments
• Right-of-Use Asset = Lease Liability + Initial costs (if any) + Pre-payments (if any) – Lease incentives (if any)

Assumptions:

• You lease an office for 3 years (or 36 months), starting 1/1/2022.
• Monthly rent is $5,000 payable on the 1^st day of each month.
• Your borrowing interest rate is 6%/year.

Calculations of the lease:

• On 1/1/2022, you will make the first rent payment of $5,000; that means you will have 35 monthly rent payments in future.
• As of 1/1/2022, the present value of the 35 payments at 6% interest rate is $160,176.86 (you can use Excel to calculate this amount).
• So we have: Lease Liability = Right-of-Use Asset = $160,176.86

Journal entries for the operating lease:

On 1/1/2022:

• Record the first rent payment:

• Record the lease liability and asset:

On 2/1/2022:

• Record the rent payment:

• Record the amortization:

Notes:

• Amortized lease liability: 160,176.86 x (6%/12) = 800.88
  • Amortized right-of-use asset: 5,000 – 800.88 = 4,199.12

After these journal entries, the balances of Right-of-Use Asset and Lease Liability are as follows:

• Right-of-Use Asset: 160,176.86 – 4,199.12 = 155,977.74
• Lease Liability: 160,176.86 – 5,000 + 800.88 = 155,977.74

On 3/1/2022:

• Record the rent payment:

• Record the amortization:

Notes:

• Amortized lease liability: 155,977.74 x (6%/12) = 779.89
  • Amortized right-of-use asset: 5,000 – 779.89 = 4,220.11

After these journal entries, the balances of Right-of-Use Asset and Lease Liability are as follows:

• Right-of-Use Asset: 155,977.74 – 4,220.11 = 151,757.63
• Lease Liability: 155,977.74 – 5,000 + 779.89 = 151,757.63

You continue to record these journal entries every month until the last rent payment on 12/1/2024. At this time, the Right-of-Use Asset and Lease Liability will be completely written off and their balances are zero.

(Attached is an illustrative Excel spreadsheet for all journal entries from the first to the last rent payment).