How Lease Liabilities Are Presented on the Balance Sheet

Graziano Stefanelli
Oct 2
3 min read

Lease liabilities represent the present value of future lease payments that a company is contractually obligated to make under lease agreements. With the adoption of IFRS 16: Leases and ASC 842: Leases (US GAAP), most leases are now recognized on the balance sheet, eliminating the distinction between operating and finance leases for lessees in terms of recognition. This shift ensures that financial statements reflect the full extent of a company’s contractual obligations and provide transparency about its use of leased assets.

Lease liabilities arise from long-term contractual obligations.

A lease liability is recorded when a company enters into a lease that gives it control over the right to use an asset for a specified period. The liability equals the present value of lease payments that are not yet paid, discounted using the interest rate implicit in the lease or the lessee’s incremental borrowing rate.

Lease liabilities include:

Fixed lease payments.
Variable lease payments tied to an index or rate.
Expected amounts under residual value guarantees.
Payments for purchase options if reasonably certain of exercise.

For example, if a company signs a five-year lease requiring annual payments of 50,000, discounted at 6 percent, the present value of these payments (about 210,000) is recorded as a lease liability.

Presentation on the balance sheet distinguishes current and non-current portions.

Lease liabilities are split into current and non-current classifications. The current portion represents lease payments due within the next twelve months, while the remainder is classified as non-current.

For example:

Lease Liabilities (current): 40,000
Lease Liabilities (non-current): 170,000
Total Lease Liabilities: 210,000

This structure ensures clarity about obligations due in the short term versus longer-term commitments.

Journal entries illustrate recognition and subsequent measurement.

At lease commencement:

Debit: Right-of-Use Asset 210,000
Credit: Lease Liability 210,000

To record a lease payment of 50,000 (first year, including 12,600 interest and 37,400 principal):

Debit: Lease Liability 37,400
Debit: Interest Expense 12,600
Credit: Cash 50,000

This approach ensures that lease liabilities decrease as payments are made, while interest expense reflects the cost of financing.

Standards provide detailed guidance on recognition.

IFRS 16 requires recognition of virtually all leases on the balance sheet, except for short-term leases (12 months or less) and leases of low-value assets.
ASC 842 (US GAAP) also requires lessees to recognize right-of-use assets and lease liabilities for both operating and finance leases, although expense recognition patterns differ.

This alignment between IFRS and US GAAP significantly increased reported liabilities for companies heavily reliant on leases, such as airlines, retailers, and logistics firms.

Lease liabilities impact solvency and leverage ratios.

Recognizing lease liabilities increases total liabilities, which affects debt ratios, leverage measures, and credit analysis. For example, if a company has existing liabilities of 1,000,000 and adds lease liabilities of 210,000, total liabilities rise to 1,210,000. With equity of 1,000,000, the debt-to-equity ratio increases from 1.0 to 1.21.

This recognition provides a more faithful picture of financial risk by reflecting obligations that were previously off-balance-sheet under older standards.

Disclosures provide transparency about lease commitments.

Both IFRS 16 and ASC 842 require extensive disclosures, including:

Maturity analysis of lease liabilities by year.
Interest expense on lease liabilities.
Total cash outflows for leases.
Reconciliation of opening and closing balances of lease liabilities.

These disclosures allow investors and creditors to evaluate the impact of leasing on liquidity, solvency, and future cash flows.

Lease liabilities ensure accurate representation of contractual obligations.

By requiring recognition of lease liabilities on the balance sheet, accounting standards provide stakeholders with a more transparent view of a company’s financial obligations. This treatment improves comparability across firms and prevents understatement of liabilities. The reporting of lease liabilities, together with right-of-use assets, captures both the resources controlled and the obligations owed, aligning financial reporting with the economic reality of leasing arrangements.

_________

DATA STUDIOS

datastudios.org