Present value of lease payments explained

Present value, commonly referred to as PV, is the calculation of what a future sum of money or stream of cash flows is worth today given a specified rate of return over a specified period of time.

Under the new lease accounting standards, lessees are required to calculate the present value of any future lease payments to determine the obligations to be recorded on the balance sheet for both operating and finance leases. The calculation is performed using the term and payments specified in the lease and a rate of return that is specific to either the lease or the organization. The present value of the lease payments is used to establish both a lease liability and a Right-of-Use (ROU) asset.

PV (Present Value) vs. NPV (Net Present Value)

Accountants occasionally use the terms, present value and net present value interchangeably, but they do have distinct meanings. PV, or present value is used to calculate today’s value of future payments or receipts, but not combined payments and receipts. In lease accounting, we use present value to establish the assets or liabilities related to lease obligations or lease receivables.

Net present value, or NPV, is commonly used in capital budgeting decisions and other types of financial analyses as a way to determine the benefit of investing in a particular capital asset. In this usage “net” means the calculation is using both inflows and outflows of cash. A potential investor may use this calculation to analyze the value of combined payments and receipts to understand what the cumulative profit or loss of an investment over time will actually be.

Minimum lease payments and future lease payments

Under the new lease accounting standards, there is no change to how we calculate the present value of lease payments. What has changed, however, is that under ASC 842, IFRS 16, and GASB 87, the present value of lease payments calculation is required for all leases. Organizations reporting under IFRS 16 and GASB 87 will only have finance leases upon transition and will continue to discount the future lease payments for these types of leases to their present value.

Specific to ASC 842, lease payments for both operating and finance type leases will also need to be discounted to their present value. Furthermore, the definition of lease payments under ASC 842 has changed slightly from the definition of minimum lease payments under ASC 840.

Minimum lease payments

Under the legacy leasing standard, ASC 840, the FASB requires lessees to establish a lease liability and lease asset for all leases that meet the criteria for a capital lease. For leases classified as capital, lessees perform a calculation to determine the present value of minimum lease payments (PVMLP) that is used as a basis for the capital lease asset and liability values. Within ASC 840-10-25-6, this standard defines minimum lease payments as the financial obligations that a lessee must make in connection with the leased asset. These payments specifically include:

  • Minimum rental payments required by the lessor over the lease term
  • Residual value guarantees
  • Penalties that the lessee incurs upon failure to renew or extend the lease
  • Payments made before the beginning of the term
  • Fees paid by the lessee to the owners of a special purpose entity for structuring the transaction

Contingent rentals and executory costs are not included in the minimum lease payments.

Future lease payments

Under the new leasing standard, ASC 842, lessees are required to establish a lease liability and a right-of-use asset for both operating and finance leases (previously capital leases). Lessees perform a present value calculation of the future lease payments to determine the initial lease liability recorded on the balance sheet.

Future lease payments are defined in ASC 842-10-30-5 as payments that relate to the use of the underlying asset during the lease term. These payments include:

  • Fixed payments required by the lease agreement, such as base rent
  • In-substance fixed payments required by the lease agreement (In-substance fixed payments are payments that may appear to be variable, but are, in effect, unavoidable. Common examples of in-substance fixed payments are fixed common area maintenance charges, fixed tax payments, and fixed insurance payments.)
  • Variable lease payments that depend on an index or rate, initially measured using the index or rate at the lease commencement date
  • The exercise price of a purchase option if the lessee is reasonably certain to exercise that option
  • Penalties for terminating the lease if the lease term reflects the lessee exercising the option to terminate the lease
  • Fees paid by the lessee to the owners of a special purpose entity for structuring the transaction
  • For the lessee only, the amounts probable of being owed by the lessee as the result of a residual value guarantee

Future lease payments are reduced by incentives paid to or payable to the lessee and exclude amounts allocated to non-lease components, any guarantee of the lessor’s debt by the lessee and variable lease payments, other than those specified above.

How to calculate lease payments using Excel in 5 steps

Under the new lease accounting standards, lease capitalization is required for the vast majority of leases. The capitalized balance is calculated as the present value of the lease payments.
Therefore, to comply with the new lease standards, you will need to know how to calculate the present value of lease payments. This is especially true if you do not plan on using any software and would prefer to use Excel spreadsheets to manage your leases. However, we believe managing your leases in Excel leaves too much room for error.

If you prefer Excel, we can at least help you use it correctly. Here are your two simple options:

  1. Calculate the present value of lease payments only, using Excel
  2. Calculate the present value of lease payments AND amortization schedule using Excel.

This article will address how to calculate the present value of the lease payments using Excel. We also built an Excel template that performs this calculation for you automatically.

Get the free Present Value Calculation Template to follow along

Present Value Calculator

Step 1: Create your table with headers

In an Excel spreadsheet, title three columns with the following headers: Period, Cash and Present Value, as shown below:

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Step 2: Enter amounts in the Period and Cash columns

Enter the number of payment periods in the Period column. In this example we are calculating the present value of ten periods of payments due at the beginning of the period, so periods are numbered 0 to 9. Note that if payments were made in arrears, the numbering would start from 1 to 10.

Next, enter the cash payment amounts for each period in the Cash column. This example starts with payments of $1,000, increasing 5% annually. See below for an illustration:

Excel 2

Step 3: Insert the PV function

Go to the first row of the Present Value column, then click on the “insert function” button. From the dialogue box that pops up, select “financial” in the dropdown, then scroll down and select “PV” (which stands for Present Value).

Excel PV Function

Step 4: Enter the Rate, Nper Pmt and Fv

After you click OK, another dialogue box will pop up into which you will insert the function arguments for Excel to perform the calculation. Enter 6% as the discount rate we are using in this example. In the Nper box, enter the cell reference for the first period. Enter 0 for Pmt, and in the field for Fv enter the cell reference for the first cash payment amount. Select type as 0 (frankly, it doesn’t matter if you select 0 or 1 here because we are discounting via the period column). Once the formula dialogue box is completed, click ok for the formula to populate the first row in the Present Value column. Copy that formula all the way down.

Excel PV Function 2

Step 5: Sum the Present Value column

Once you have calculated the present value of each periodic payment separately, sum the values in the Present Value column. This sum equals the present value of a 10-year lease with annual payments of $1,000, 5% escalations and a rate inherent in the lease of 6%, or $9,586.

Excel 3

There you have it, a way to calculate the present value of lease payments using Excel.

Present value calculator

If that seems like too many steps, we have created a free, downloadable present value calculator in Excel that performs this calculation for you automatically. All you do is complete the items in yellow (enter the lease term, the payments, and specify if the payments are made at the beginning of the period or at the end of the period). The tool will then calculate the present value for you automatically. (See the image of the template below).

Present Value Calculator

Additionally, if you are using Excel to calculate both the present value of lease payments and the lease liability amortization schedule, read our follow-up blog illustrating how to calculate the present value of lease payments and get the lease amortization schedule in one step with Excel. With this method, you will have everything you need to comply with the new lease accounting rules powered only by an Excel spreadsheet.

Summary

Knowing how to calculate the present value of lease payments in Excel is necessary to comply with the new lease accounting rules. This calculation is required to record lease liabilities and related asset balances on the balance sheet, to provide more visibility of lease obligations to the users of the financial statements. All entities that must comply with any of the new lease accounting rules need to be able to accurately perform the present value calculation of the future lease payments.

Related articles

Check out the following blogs to learn more about lease accounting calculations and how to perform them.