Lease Liability
The present value of future lease payments that a lessee is obligated to make, recognized on the balance sheet.
What is Lease Liability?
A lease liability is a financial obligation recorded on a lessee's balance sheet representing the present value of all future lease payments to be made over the lease term. It was introduced into GAAP by ASC 842 (effective for public companies in 2019) and into IFRS by IFRS 16. Prior to these standards, operating leases were off-balance-sheet commitments, significantly understating the liabilities of companies with large rental obligations such as airlines and retailers. Under current standards, both operating leases and finance leases (for leases over 12 months) require recognition of a lease liability matched by an equal right-of-use (ROU) asset. The liability is reduced over time as lease payments are made, with each payment split between interest expense and principal repayment similar to loan amortization.
Example
A retailer signs a 10-year store lease with $200,000 annual payments. At inception, the present value of the payments (discounted at the lessee's incremental borrowing rate of 5%) is approximately $1.54 million. This amount appears as a lease liability on the balance sheet, offset by a $1.54 million right-of-use asset. Each annual payment reduces the liability while interest expense accrues on the remaining balance.
Source: FASB ASC 842 — Leases