# General Business Category > Accounting Forum > [Question] Smoothing Liability

## JKS

Hi Guys,

Each year a financial audit is conducted on the company I currently work for.
I've notice an account called smoothing liability, which relates to a 5 year finance lease agreement. Each year there is either a debit or credit to the income statement and balance sheet.

What I'd like to know, is how is it calculated and why?

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## geraldenek

Hi JKS

It is an IFR's standard were the total lease including yearly increases gets calculated for the 5 year period and then devided by 5 again to get the amount for the year.

This amount has got nothing to do with tax and will be taken off the tax calculation and the correct amount incurred for the year will then be deducted.

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JKS (31-Aug-11)

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## Mark Atkinson

Hi JKS,

I think what Geraldene is saying is the following:

The correct accounting treatment of an operating lease is to record what we call *equalised lease payments* each year in your Statement of Comprehensive Income (Income Statement), as opposed to the _actual_ payments for the year. The equalised lease payments, as Geraldene has pointed out, equal the total lease liability divided by the total number of lease payments. 

To my knowledge the smoothing account is used to record the differences each year between the *actual lease payments* and the *equalised payments*.

So as an example:

Say after determining your _equalised_ lease payments, in the current year it happens to be R2000 higher than your _actual_ lease payments.

This would result in a Debit to the Income Statement (Increasing the lease payment from actual to equalised) and a corresponding Credit to the Balance Sheet (the smoothing account) to the amount of R2000.  

The effect is obviously exactly the opposite if the actual payment is more than the equalised payments.

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Dave A (30-Aug-11), JKS (31-Aug-11)

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## geraldenek

Thanks Mark - sometimes i'm not that good in explaining things.

also want to mention that from last year it changed and only companies who need to comply with full IFR's needs to do this.  As for SME's (which is most of the cases for companies) don't need to do this anymore.

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Mark Atkinson (30-Aug-11)

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## Dave A

So essentially this applies to leases with a set escalation clause over the period of the lease?

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## Mark Atkinson

> So essentially this applies to leases with a set escalation clause over the period of the lease?


Yip. It would apply to any operating lease where not every payment is equal.

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## wynn

This is obviously used for a business trading in a Mall where a portion of the lease is tied to the turn over (say R1,000 per m2 and 5% of turnover)

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## JKS

I completely understand it now. thanks guys

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## geraldenek

> This is obviously used for a business trading in a Mall where a portion of the lease is tied to the turn over (say R1,000 per m2 and 5% of turnover)


Hi Wynn

No you do it with lease agreements that is more than one year with a fixed percentage esculation.  If the lease merely says "increases in line with CPI" then it would not need to be smoothed.

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## wynn

> Hi Wynn
> 
> No you do it with lease agreements that is more than one year with a fixed percentage esculation.  If the lease merely says "increases in line with CPI" then it would not need to be smoothed.


These are 5 year leases and the rate is partly calculated on 5% of the business turnover so you may have 30m2 @R1000.oo=R30,000.oo and if your turnover is R300,000.oo you pay an additional R15,000.oo so your total rent is 45,000.oo but next month your turnover is 350,000.oo your rent will increase by R2,500.oo 
It would also decrease proportionally if you have a bad month.

I don't know if all Old Mutual Properties follow this formula but Vincent Park in East London does. (My figures are thumbsucks though)

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## fabulus

> These are 5 year leases and the rate is partly calculated on 5% of the business turnover so you may have 30m2 @R1000.oo=R30,000.oo and if your turnover is R300,000.oo you pay an additional R15,000.oo so your total rent is 45,000.oo but next month your turnover is 350,000.oo your rent will increase by R2,500.oo 
> It would also decrease proportionally if you have a bad month.
> 
> I don't know if all Old Mutual Properties follow this formula but Vincent Park in East London does. (My figures are thumbsucks though)


Hi guys I work for a firm which owns a small shopping complex. I have been following this thread and i shd say it has really interested me since I am having a small hick up with the smoothing process. A number of the tenants renewed their leases during the financial year 2011 and we are closing the books for 2011. the auditors want the smoothing schedule. what do i do with the tenants who renewed leases during the year. How do i bridge the gap between the old and new lease. Also some left during the year. Do i include the rentlas they paid in my smoothing? pliz help.

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## eitnob

Rental paid has nothing to do with smoothing/straight lining.

Renewal constitutes a new lease agreement, so you start a new straightlining calculation for each lease agreement. (unless this is a renewal that was likely at the initial inception, in which case the entire period +renewal period should is deemed to be the lease term)
People should be careful to paint a lease with to broad a brush, as there are several exceptions.

The OP mentioned a finance lease in his initial post. If he is in fact referring to a finance lease then most of the replies are not correct.
As for SME's smoothing may still be required unless the escaltion specifically refers to inflation. The extarct form the IFRS reads :

"(a) another systematic basis is representative of the time pattern of the user’s
benefit, even if the payments are not on that basis, or
(b) the payments to the lessor are structured to increase in line with expected
general inflation (based on published indexes or statistics) to compensate
for the lessor’s expected inflationary cost increases. If payments to the
lessor vary because of factors other than general inflation, then this
condition (b) is not met"

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