Calculating the Lease Modification Adjustment
To show how the lease modification adjustment is calculated, the following sample lease information is used:
-
Original lease term: 3 years
-
Annual payment: 150,000
-
NPV: 408,487.20
-
Interest rate: 5%
At the end of the second year, a modification is made to extend the lease for another year. The annual lease payments remain unchanged but a new incremental interest of 8% is applied to the lease.
Calculating the Adjustment Value
To calculate the adjustment, first identify the balance at the time of modification. In the sample scenario, this corresponds to the balance at the end of the second year.
|
Period |
Date |
Lease Payments |
NPV of Lease Payments |
Balance |
Interest |
Principal |
|---|---|---|---|---|---|---|
|
1 |
12/31/2020 |
$150,000.00 |
$142,857.14 |
$278,911.56 |
$20,424.36 |
$129,575.64 |
|
2 |
12/31/2021 |
$150,000.00 |
$136,054.42 |
$142,857.14 |
$13,945.58 |
$136,054.42 |
|
3 |
12/31/2022 |
$150,000.00 |
$129,575.64 |
$0.00 |
$7,142.86 |
$142,857.14 |
|
|
|
NPV |
$408,487.20 |
|
|
|
The new NPV is then calculated using the modified lease terms. The following table shows the payment details and new NPV for the modified lease:
|
Period |
Date |
Lease Payments |
NPV of Lease Payments |
Balance |
Interest |
Principal |
|---|---|---|---|---|---|---|
|
1 |
12/31/2022 |
$150,000.00 |
$138,888.89 |
$138,888.89 |
$21,399.18 |
$128,600.82 |
|
2 |
12/31/2023 |
$150,000.00 |
$128,600.82 |
$0.00 |
$11,111.11 |
$138,888.89 |
|
|
|
NPV |
$267,489.71 |
|
|
|
If the first lease payment falls between the 1st and the 15th of the month, it falls under Period 0. No interest should be computed and the principal amount should equal the lease payment amount. For more information, see Lease Amortization Schedule Subtab.
The lease modification adjustment is the difference of the new NPV and the balance at period of modification.
New NPV: $267,489.71
Balance: $142,857.14
Lease modification adjustment: $124,632.57
If the new NPV is higher than the balance, the difference is a positive adjustment value. This value is added to the lease liability. If the new NPV is lower than the balance, the difference is a negative adjustment value. This value is subtracted from the lease liability.
The write-down adjustment calculation from a modification is the same for both operating and finance lease. The write-down adjustment is the difference between the lease liability balance at the effective date of modification and the new NPV using the updated lease terms.