Understanding a lease liability

Definition

A lease liability is the amount you still owe for future payments on a lease. On the books, this is a liability, not rent for this month and not the building itself.

It pairs with a right of use asset. This page is the owe; that other line is the remaining right to occupy the space.

Cash-basis books often skip this line and record rent when paid. Accrual books that follow current lease rules put the obligation on the Balance Sheet when the lease starts.

The balance is remaining payments, often measured from the lease contract. Interest on the remaining obligation hits the P&L as time passes.

Where it shows up

Balance Sheet: Located with the longer-term amounts owed, with the next twelve months split into current.

P&L: Related to interest on the remaining obligation.

Cash flow: Decreases in this account, reported cash from financing activities decreases.

See also: Right Of Use Asset · Long-Term Liabilities · Rent Expense

When you look at your Balance Sheet, the longer-term slice of this owe sits with long-term liabilities. The next twelve months are often shown with current liabilities.

When the total is high, it usually means a long remaining term on a studio, a shop, or a vehicle lease. When the total is low, it usually means the lease is short, nearly finished, or the books record rent instead.

The profit and loss statement does not list this account as a line. Interest on the remaining obligation is the related charge each period.

On the Statement of Cash Flows, paying this owe is a financing outflow. This account falls, and reported cash from financing activities falls with it.

How it works

The owe gets onto the books when you sign a lease that is more than a short-term rental. You credit this account and debit the right of use asset for the same measured amount.

Cash stays put unless a first installment is paid that day. The contract is what sets the remaining payments.

Each period, part of the cash payment reduces this liability. The rest of that payment is interest on the remaining obligation.

The next twelve months of this owe are often split into current. That split is the same idea as Current Portion Of Long-Term Debt on a bank note.

The rest stays with the longer-term amounts owed. Paying a regular installment drops cash and drops this account; it does not re-record the original lease.

Keep a supporting schedule of each lease, its remaining payments, and the current slice. A studio still under lease should be on that list; a lease that ended last year should not.

When the lease ends, this account should sit at zero. If you then buy the space, that purchase is a new owned asset, not leftover lease owe.

A month-to-month stall you can walk away from often never lands here. Ordinary rent expense is the charge for that kind of occupancy.

Example

A yoga studio signs a four-year lease on its practice room. The remaining payments are measured at $48,000 on the start date.

The studio records:

Debit: Right of use asset $48,000

Credit: Lease liability $48,000

The right of use asset goes up by $48,000, and the lease liability goes up by $48,000. Cash has not moved.

The Balance Sheet is larger on both sides. The Income Statement has not taken $48,000 of rent that day.

Later the studio pays $1,000, of which $800 reduces the owe:

Debit: Lease liability $800

Credit: Cash $800

This account falls by $800, and cash falls by $800. The $200 interest piece is a P&L charge, recorded on its own.

Common mix-ups

A lease liability is not rent expense. Month-to-month or cash-basis rent hits the P&L when paid; this line is the remaining owe under a longer lease.

This account is not the right of use asset. That asset is the unused right to occupy the space; this line is what you still have to pay.

This line is not the building. You do not own the studio; you owe the remaining payments for the right to use it.

Related terms

• Right Of Use Asset: The asset recorded for the right to use leased property over the lease term.
• Long-Term Liabilities: Obligations that come due more than a year out.
• Rent Expense: The periodic cost of occupying leased space.
• Current Portion Of Long-Term Debt: The slice of loan principal due within the next twelve months.
• Supporting Schedule: A detailed worksheet backing up a single line on the financial statements.
• Interest Expense: The cost of borrowing recorded for the period.
• Balance Sheet: A statement showing what a business owns, what it owes, and what is left for owners at a single point in time.
• Contract: The binding agreement that sets what will be delivered and what will be paid.