The present value of the rents at the discount rate, at the inception of the lease. For normal leases under FAS 13, this is the same as the right-of-use asset. Under ASC 842/IFRS 16, the initial liability is reduced from the present value of the rents by any rents paid on or before the inception of the lease (and the right-of-use asset may be increased by initial direct costs and reduced by lease incentives).
Once the lease begins, the liability is reduced according to the "interest method." If accrued interest is shown separately, then for each rent payment, any accrued interest is paid off, and the remaining finance rent (after deducting any operating rent and executory costs) reduces the liability balance. Interest then accrues on the remaining liability. This is the same method used for a typical home mortgage. At the normal expiration of a lease, the liability balance will be zero, unless there is a guaranteed residual; in that case, the remaining liability plus accrued interest, if any, will be equal to the guaranteed residual.
Alternatively, if accrued interest is included in the liability, interest accrues during the rent payment period and is added to the liability. When a rent payment is made, the entire amount is drawn down from the liability, then interest accrues again for the next payment period.
See also
Current liability | Long term liability |