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Introduction

As businesses navigate evolving accounting standards like ASC 842 and IFRS 16, understanding the intricacies of lease amortization schedules has become more important than ever. It not only helps businesses monitor their payment timings but also improves the accuracy of financial reporting and compliance. 

This blog will cover everything one needs to know about the lease amortization schedule – what it is, how to calculate lease amortization, benefits of the lease amortization schedule, and more. 

Table of Contents

    • Introduction
    • What is Lease Amortization?
    • How is Lease Amortization Calculated?
    • What Is a Lease Amortization Schedule? 
    • Benefits of Using a Lease Amortization Schedule
    • How to Create a Lease Amortization Schedule?
    • Prepare An Amortization Schedule
    • Enhance Your Accounting Reporting With HighRadius’ Record To Report Software
    • FAQs

What is Lease Amortization?

Lease amortization is the process of reducing the value of an asset in the lease agreement, based on historical cost, economic lifespan, and residual value. Consequently, the total debt related to the asset is amortized each month, ensuring a clearer picture of the asset’s value over time. 

Businesses must gain an in-depth understanding of calculating lease amortization schedules, as it is fundamental for creating accurate journal entries and complying with ASC 842. A lease amortization schedule is designed to highlight the timing of lease payments and divide them between interest and principal components. It reflects the reduction in lease liability balance over the period. The basic idea is to break down the net present value of future lease payments into installments. This way, businesses get clarity into cost distribution and make informed decisions. 

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What does the ASC 842 rule for lease accounting say? 

ASC 842 lease accounting  is an accounting standard issued by the Financial Accounting Standards Board (FASB) that requires businesses to report leases longer than 12 months as assets or liabilities on their balance sheets. The goal is to improve transparency, comparability and ensure that lease obligations are accurately reflected in financial statements. 

There are two key elements of ASC842 lease accounting:

  • Right-of-use (ROU) asset

This shows a lessee’s right to use an underlying asset for the lease term. To determine its value, businesses have to calculate the present value of lease payments, adjust it for any direct costs, lease incentives received, and any prepaid or accrued lease payments. 

  • Lease liability 

This denotes the obligation to make lease payments over the lease term. It’s calculated as the present value of lease payments, discounted at the rate mentioned in the lease or incremental borrowing rate if the discount rate cannot be determined. 

How is Lease Amortization Calculated?

Under ASC 842, businesses have to follow different amortization calculations for operating leases and financial leases. To calculate lease expenses for any reporting period, start with the lease liability, representing the present value of future lease payments. 

  • Lease amortization calculation for operating leases

For operating leases, the total expenses are derived using the straight-line method over the lease term. This means that the lease expense is consistent throughout the lease term. The lessee is responsible for making periodic payments for the leased asset. The remaining liability is included as an interest expense. This usually involves assets that have a net present value (NPV) of 90% of the lease’s value. 

Lease amortization calculation for operating leases

Suppose a business leased an asset with a total lease payment of $60,000 and a lease term of 5 years or 60 months. So, as per the straight line expense method, the monthly lease installment will be: 

Monthly expense = $60,000/60 

Monthly expense = $1000

And the journal entry would look like this: 

ParticularDebit Credit
Lease expense a/c$1000
To cash/bank a/c $1000
(Monthly lease expense paid for operating lease)
  • Lease amortization calculation for finance lease

For a finance lease, the entire ownership is transferred to the lessee and they record both the ROU asset and lease liability. This means the business is responsible for maintaining the leased asset, including insurance and taxes, till the end of the lease term. The initial lease liability combined with all direct costs, interest expenses, and incentives adds up to ROU. This is amortized monthly until the final payment. When no residual value is left, the ROU asset will automatically become zero. 

To record the transaction in the books, a business first has to record the ROU separately and then account for the asset-related expenses. Suppose a business has a financially leased asset with a principal payment of $50,000 and a monthly installment of $800,  including an interest expense of $200. 

ParticularDebit Credit
ROU asset a/c$50,000
To Lease liability a/c $50,000
(Recording lease liability at the start of the lease)
ParticularDebit Credit
Interest expense a/c$200
Lease liability$600
To cash/bank a/c $800
(Monthly lease and interest expense paid for finance lease)

What Is a Lease Amortization Schedule? 

A lease amortization schedule is a tabular representation of financial data relating to lease payments, interest expenses, and other amortization of lease liability and ROU asset. These schedules are created monthly, throughout the lease term. 

Businesses usually prepare a draft of amortization schedules at the beginning of the lease term. This further helps them use these schedules as a reference for estimating future payments to be made throughout the lease period. 

For instance, during the lease term, an accountant will frequently use a lease amortization schedule to verify if all payments, interests, and amortization principal are accurately shown on the financial statements. The lease amortization schedule can thus be regarded as a source of truth for lease related activities.  

Benefits of Using a Lease Amortization Schedule

Creating a lease amortization schedule offers many benefits: 

  • Supports financial planning and manages reserves effectively
  • Ensures accurate reporting when reflecting lease amortization
  • Ensure compliance when recording lease expenses 
  • Fosters informed decision-making about leasing arrangements
Benefits of using a lease Amortization
  • Financial planning

The lease amortization schedule provides businesses a clear overview of payment distribution, supporting effective planning of finances and cash reserves. 

  • Accurate and consistent reporting 

Preparing lease amortization schedules ensure that lease expenses and other related direct costs are accurately reflected in the financial statements, in adherence to ASC 842 or IFRS 16. 

  • Greater compliance 

It’s essential for businesses to comply with the accounting standards when recording lease expenses. Moreover, a proper lease amortization schedule can help optimize tax treatment, as businesses may be able to deduct lease expenses, reducing their overall tax liability.

  • Drive informed decisions 

Accurate amortization data supports informed decision-making regarding lease renewals, terminations, or negotiations, allowing businesses to optimize their lease portfolios. It also provides insights into future lease liabilities, ensuring accurate allocation of funds. 

How to Create a Lease Amortization Schedule?

Here’s how to create a lease amortization schedule:

  1. Gathering information 
  2. Selecting the payment timing
  3. Compute the beginning liability balance
  4. Setting up amortization schedules
  5. Filling in period numbers
  6. Computing interest expenses
  7. Computing principal payment 
  8. Computing ending balance
  9. Visualizing the data

Step 1: Gather Information

Gather necessary information regarding the lease, including frequency and number of payments, the amount remitted, lease term, and the discount rate. 

Step 2: Selecting payment timing 

Determine whether the s payments are made at the beginning or end of each period. 

Step 3: Computing liability balance at the beginning 

Compute the net present value (NPV) of all remaining future payments. This value will act as the business’s beginning liability balance. 

Step 4: Setting up amortization schedules

Create a table with columns for the period, interest expense, beginning balance, interest expense,  principal payments, and ending balance. 

Step 5: Filling in period numbers

Start with the first batch and proceed to the final period of the lease term. 

Step 6: Computing interest expense 

Based on your selected period for payment, calculate interest expenses for the lease period. For the beginning-of-the-period payments, a business has to apply the interest rate to the ending balance d of the previous period. And for the end-of-period payment, the beginning balance is to be used. 

Step 7: Computing principal payment 

From the cash payment, subtract the interest expense to determine the principal payment. 

Step 8: Computing the ending balance 

From the beginning balance reduce the principal payment to get the ending balance for the current period. 

Step 9: Repeating the process

Continue the process and calculate the balance and direct expenses for each period until the lease term is complete.  

Step 10: Visualizing the data

Build graphs like a line chart to visualize the gradual reduction of the lease liability balance over time. 

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Prepare An Amortization Schedule

The most common way to create amortization schedules is through manual calculation using spreadsheets. But to gather information, maintain accuracy and compliance, and then scale with spreadsheets is a mammoth task. Another alternative is to use lease management software. However, legacy tools often lack flexibility or customization and are too hard to integrate with existing ERPs. 

A robust record-to-report software comes with advanced features to help businesses increase the consistency and accuracy of reporting lease amortization and comply with accounting requirements. 

  • Financial consolidation and reporting 

Businesses can get real-time visibility into transactions and seamlessly integrate with ERPs using financial consolidation and reporting software. They will also be able to map with different accounts, standardize reporting, and track consolidation readiness. The cherry on top is that the solution also allows businesses to auto-sync budgeted expenses vs. actuals at group levels so they can improve their decisions. 

  • Removing anomalies 

Any errors or anomalies in calculating interest expense or principal payment can significantly impact the lease amortization schedule. AI-led anomaly management software can help detect these errors early on and analyze the general ledger line items and general ledger balances extracted from ERP. The transaction is flagged as an anomaly based on pre-built algorithms. 

  • Automated data extraction and real-time visibility

An automated record-to-report software offers automated data ingestion from a system of records. Businesses just have to set up once using LiveCube and automate transaction processing. This will help businesses templatize data processing, eliminate manual effort and reduce errors. 

The time saved from automated data extraction and templates can be utilized in strategizing and streamlining lease payments and focusing on better reporting. They can also use LiveCube’s out-of-the-box formula to create spreadsheet-like, no-code templates to handle large volumes of data easily and build amortization schedules. 

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HighRadius offers a cloud-based Record to Report Software that helps accounting professionals streamline and automate the financial close process for businesses. We have helped accounting teams from around the globe with month-end closing, reconciliations, journal entry management, intercompany accounting, and financial reporting.

Our Financial Close Management Software is designed to create detailed month-end close plans with specific close tasks that can be assigned to various accounting professionals, reducing the month-end close time by 30%. The workspace is connected and allows users to assign and track tasks for each close task category for input, review, and approval with the stakeholders. It allows users to extract and ingest data automatically, and use formulas on the data to process and transform it. 

Our Account Reconciliation Software provides an out-of-the-box formula set that can configure matching rules and match line-level transactions from multiple data sources and create templates to automate various transaction processing required for month-end close. Our solution has the ability to prepare and post journal entries, which will be automatically posted into the ERP, automating 70% of your account reconciliation process. 

Our AI-powered Anomaly Management Software helps accounting professionals identify and rectify potential ‘Errors and Omissions’ throughout the financial period so that teams can avoid the month-end rush. The AI algorithm continuously learns through a feedback loop which, in turn, reduces false anomalies. We empower accounting teams to work more efficiently, accurately, and collaboratively, enabling them to add greater value to their organizations’ accounting processes.

FAQs

  1. Are capital leases amortized or depreciated? 

Yes, capital leases are both depreciated and amortized. The leased asset is depreciated over its useful life and is recorded in the balance sheet. At the same time, the lease liability is amortized over the life of the lease. This is similar to an asset being amortized when purchased with a payment amortized loan. 

  1. How to create a lease amortization schedule in Excel? 

Here’s how to create a lease amortization schedule in Excel: 

  • Open a blank spreadsheet. 
  • Select five columns. 
  • Enter the number of periods and expenses. 
  • Enter the formulas for expenses, liability reduction, and liability balance. 
  • Perform scenario analysis on the liability balance. 
  1. How to create a lease payment amortization schedule? 

Here’s how to create a lease amortization schedule:

  • Collect necessary information
  • Choose payment timing
  • Calculate the initial liability balance
  • Establish amortization schedules
  • Input period numbers
  • Calculate interest expenses
  • Determine principal payments
  • Calculate ending balance
  • Visualize the data
  1. How to record lease amortization on the balance sheet? 

To record lease amortization on the balance sheet, debit “amortization expense” and credit “accumulated amortization” for the lease amortization amount calculated each period. The accumulated amortization account here acts as a contra-asset account that reduces the carrying value of the ROU on the balance sheet. 

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