Breakdown
How it works
The liability is the present value of fixed lease payments (including fixed escalations) discounted at the rate implicit in the lease or the lessee's incremental borrowing rate. The right-of-use asset equals the liability plus initial direct costs and prepaid rent, less incentives, and is depreciated straight-line. Interest unwinds on the liability, so total expense is front-loaded.
Formula
Worked example
120,000 a year in advance, 5 years, 3% escalation, 6% IBR: liability ≈ 567,000; interest over the term ≈ 70,000; depreciation 113,400 a year.
Frequently asked questions
Which rate do I use?
The rate implicit in the lease if determinable; otherwise your incremental borrowing rate for a similar term and security — ask your bank or use your latest term-loan rate plus a margin.
Are service charges included?
Non-lease components (service charges, utilities) are excluded unless you elect the practical expedient to combine them.
What about renewal options?
Include option periods you are reasonably certain to exercise; this materially increases the liability for retail leases.