USA ASC 842 Lease Accounting

[HowToAccount]

Hi,

My question is regarding accounting for the new lease ASC 842 rule for a 5 year lease that has escalating payments with payments due monthly.

I calculated the present value of the lease and ROU, but I can't figure out how to amortize it on a monthly basis. Below is my lease with escalating payments (1.5%) every year. When I perform the amortization schedule on a yearly basis, using a 9% interest rate, I get the following clean looking schedule that amortizes down to zero.

When I try to break it out by month with the same interest rate of 9% and same cash payment in total I'm not getting my total lease liability expense (interest) to be equal to my yearly. Below, you can see for my first month I'm showing $26,394 vs. above $28,542 which is making it impossible to amortize my lease liability to zero the way I have when I look at it yearly.

What am I doing wrong here? Is there some time value of money I'm not taking in to effect here?

If there is a solution can you point me to the specific language (or equivalent) that addresses this specific issue so I can communicate it to folks who are not in the accounting world more smoothly?

Thank you,

 

[DrStrangeLove]

You initial payment and interest on the remaining balance aren't too far off, actually. At 9.00% per year over 5 years versus 60 months, the annual amortization and the monthly amortization won't be too far apart. If it were 30 years versus 360 months, you'd see a material difference in the total payments per year.

In the annual case, you're accruing interest once per year, and it compounds for the whole year. That's the same as charging the equivalent interest monthly and letting it compound for the whole year. So for each month's interest, you're getting interest-on-interest for the remainder of the year thrown on top each month. Then once a year, you pay all the accumulated interest, and the cycle starts again. In the monthly case, you're accruing interest every month, but you're paying it off every month, so there's no interest-on-interest that accumulates. So you pay less in total interest, and thus your monthly payment will be less than in the annual case.

I could point you to sources with more specific language, but they'll be very mathematical (e.g., Kellison's Theory of Interest, an actuarial textbook).

 

[HowToAccount]

That's very helpful, thank you.

I need the liability to amortize to zero so I think I'll just pro-rata add the $15k or so variance I have at the end of the period back in to each of the 60 months. I think that would be a fair representation. Interested in your opinion about that.

Also, I appreciate the reference!

 

[DrStrangeLove]

You can do it that way. But I think if you just extend your formulas out for 60 months, make sure your formulas in the Cash column reflect the right payment pattern, and use the Solver, you can get the exact solution. Either way works.