Variable Lease payments example

NotesQuiz

Variable Lease payments example

10 year Lease contract:

500 payable at the start of every year
Increased payments every 2 years to reflect the change in the consumer price index

The consumer price index was 125 at the start of year 1
The consumer price index was 130 at the start of year 2
The consumer price index was 135 at the start of year 3

(so these are variable payments based upon an index / rate)

ANSWER (IGNORING DISCOUNTING)

Start of year 1:

Dr Asset 500 Cr Cash 500
Dr Asset 4500 Cr Lease Liability 4500 (9 x 500)

End of year 2:

Asset will be 5,000 - 1,000 (straight line depreciation) = 4,000
Lease liability will be 8 x 500 = 4,000

End of year 3:

Lease payments are now different - 500 x 135/125 = 540

So the lease liability will be 7 x 540 = 3,780 
Asset will be 4,000 - 500 (depreciation) + 280 (re-measurement of Liability) = 3,780

(Please note that this example ignored discounting - which would normally happen as the liability is measured as the PV of future payments)

Variable payments that are really fixed payments

These are included in the liability as they're pretty much fixed and not variable 

e.g. Payments made if the asset actually operates 

(well it will operate of course and so this is effectively a fixed payment and not a variable one)

NotesQuiz