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For operating leases, a lease expense is recorded in a single financial statement line item on a straight-line basis over the lease term. This differs from a finance lease that includes both amortization and interest expense.
Straight-Line Expense:
Periodic straight-line expense at the lease commencement date is based on the sum of the following, divided by the periodic lease term:
The total lease payments under the lease
+ Any initial direct costs incurred by the lessee
- Any lease incentives received from the lessor
A lessee records the straight-line expense on the income statement. The income statement will also include any variable lease payments not included in the lease liability and any impairments recorded in the period.
ROU Asset Reduction:
The ROU Asset is reduced periodically by computing the difference between the straight-line expense and the accretion of interest on the lease liability each period. Although the period interest expense is not recorded, it is calculated in order to accrete the lease liability and reduce the ROU asset, as show below:
Period Interest Expense* - Straight-Line Expense = ROU Asset Reduction
*Period Interest Expense is calculated as follows:
Beginning Lease Liability x Period Discount Rate = Period Interest Expense
Lease Liability
Lease liabilities are measured the same way regardless of lease classification. In each period, the liability will reflect an increase due to period interest expense which is offset by a period lease payment, as shown below:
Beginning Lease Liability + Period Interest Expense - Period Lease Payment = Ending Lease Liability
Accounting Guidance Referenced:
- ASC 842-20-25-6
- ASC 842-20-25-8
- PwC Leases October 2020 4.4
- Deloitte A Roadmap to Applying the New Leasing Standard (2020) 8.4.3.2