The process of determining the increase in a lease liability due to the passage of time is a critical aspect of lease accounting under generally accepted accounting principles. This increase, often calculated periodically (e.g., monthly, quarterly, annually), represents the unwinding of the discount applied to the initial lease liability. For example, if a company initially records a lease liability of $100,000 based on the present value of future lease payments, this amount will subsequently grow over the lease term as interest is accrued. The calculation involves applying the discount rate implicit in the lease (or the lessee’s incremental borrowing rate if the implicit rate is not readily determinable) to the outstanding balance of the lease liability at the beginning of each period.
Accurately determining this growth is essential for maintaining compliance with financial reporting standards. It ensures the lease liability is properly reflected on the balance sheet and that lease expense is recognized correctly over the lease term. Prior to the current lease accounting standards, many leases were kept off-balance sheet, obscuring a company’s true leverage. Proper measurement of this growth allows for a more transparent and accurate representation of a company’s financial obligations and enables better comparability between companies that lease assets and those that purchase them outright. This is also important for investors and creditors to accurately asses a company’s solvency and liquidity.
