Lease Liability (Present Value)

The lease liability is the present value of the lease payments not yet paid at the commencement date, discounted at the rate for the lease. It is the figure everything else follows from: the right-of-use asset is built on top of it, the interest charge comes out of it, and the disclosure notes report on it.

Which payments go into the liability

FRS 102.20.51 sets out what the lease payments comprise. Getting this list right at commencement matters more than any other input, because an omitted payment understates the liability, the asset and the depreciation charge for the whole term.

FRS 102 Reference: FRS 102.20.51

Lease payments included in the liability per FRS 102.20.51
Payment type	What it means in practice
Fixed payments	The regular rent, less any lease incentives receivable from the landlord
In-substance fixed payments	Payments that are nominally variable but effectively fixed, for example a turnover rent with a minimum floor equal to the base rent
Variable payments based on an index or rate	Included at the index or rate as it stands at the commencement date, not at a forecast future level
Residual value guarantees	The amount you expect to have to pay under the guarantee
Purchase option price	Only when you are reasonably certain to exercise the option
Termination penalties	Only when the lease term reflects you exercising a termination option

What stays out

Two things are deliberately excluded. Variable payments linked to performance or usage, such as turnover rent above a threshold or mileage charges on a vehicle, are expensed as they are incurred rather than capitalised. Separated service components also stay out, unless you have applied the practical expedient not to separate them.

The most common overstatement

Putting a service charge into the liability inflates every figure that follows from it. If your rent demand bundles rent and service charge, split them before you measure, or apply the practical expedient deliberately and disclose that you have.

The calculation

The liability is the present value of those payments at the discount rate for the lease. Lease102 discounts on actual dates using Act/365, which is the same basis as Excel's XNPV, so a schedule can be checked line by line against a spreadsheet.

Present value calculation

Given: Monthly payment: £1,000 Lease term: 36 months Annual discount rate: 5% Monthly rate = 5% / 12 = 0.4167% PV = £1,000 x [(1 - (1.004167)^-36) / 0.004167] PV = £33,531.97

A rent-free period does not pause the interest

This is the point that most often surprises people moving from operating lease accounting. During a rent-free opening the liability still accrues interest; there is simply no payment reducing it, so the balance grows. The rent-free months are part of what you discounted, not a gap in the lease.

Office lease, three months rent-free

Annual rent £24,000 (£2,000/month, in advance) Term 5 years (60 months) Rent-free First 3 months Discount rate (OBR) 5.50% per annum Liability at commencement: 57 payments of £2,000 discounted at 5.50% -> approximately £100,424 Month Opening Interest Payment Closing 1 £100,424 £460 £0 £100,884 2 £100,884 £462 £0 £101,346 3 £101,346 £464 £0 £101,810 4 £101,810 £467 £2,000 £100,277 The balance RISES for three months, then starts to fall.

How the liability moves after Day 1

After initial recognition the carrying amount is increased by interest using the effective interest method, reduced by the payments made, and remeasured on a reassessment or a modification. The interest goes to profit and loss as a finance cost, which is why adopting Section 20 moves cost out of operating expenses and into interest and depreciation.

FRS 102 Reference: FRS 102.20.62-20.64

Interest each period

Opening lease liability multiplied by the periodic discount rate. Front-loaded by construction: the balance is largest at the start, so the interest charge is too.

Principal each period

The payment less the interest for that period. Closing liability equals opening liability plus interest less payment.

Why Year 1 profit falls

Depreciation is straight line but interest is front-loaded, so the combined charge in early years exceeds the old straight-line rent expense even though the cash paid is unchanged. The effect reverses over the term.

Current and non-current split

For the balance sheet the liability is split between amounts falling due within twelve months of the reporting date and amounts falling due after. Lease102 derives the split from the amortisation schedule rather than apportioning the balance, so it reflects the actual principal profile including any rent-free or stepped periods.

Checking the number

Every schedule can be reconciled against a spreadsheet. Export the amortisation schedule and compare the opening liability with Excel's XNPV over the same dated cash flows.

Excel verification

Use the Act/365 (XNPV) day count convention so the platform and Excel agree to the penny. A mismatch almost always means the payment dates, not the rate, differ between the two.

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