Variable payments fall under two major categories:

  1. Variable payments that depend on an index or a rate
  2. Other variable payments

Variable payments that depend on an index or a rate – accounting treatment

  • Include in the initial measurement of the lease using the index or rate as at the commencement date.
  • Remeasure lease in the period the rate or index changes.

Example 1

Lessee enters into a 10-year lease of property with annual lease payments of $50.000 payable at the beginning of each year.

The contract specifies that lease payments will increase every two years in line with the increase in the Consumer Price Index for the preceding 24 months. The Consumer Price Index at the commencement date is 125. The lessee has determined the appropriate rate to discount lease payments is 5%.

At the commencement date, Lessee makes the lease payment for the first year and measures the lease liability at the present value of the remaining nine payments of $50.000, discounted at the interest rate of 5% per annum, which is $355.391.

Solution 1

Lessee initially recognizes assets and liabilities in relation to the lease as follows:

Dr Right-of-use asset $405.391

                                Cr Lease liability $355.391

                                Cr Cash $50.000 (lease payment for the first year)

In measuring the lease liability, Lessee does not make any estimate of how future changes in CPI will impact future lease payments. Rather it assumes the initial lease payment will remain constant during the lease term.

Other variable payments – accounting treatment

  • Do not include in the initial measurement of the lease.
  • Recognize in profit or loss (or in the carrying value of another asset as required by another Standard) when the event or condition that triggers the payments occur.

Example 2

Lessee enters into a 15-year lease of retail space in a shopping center. There are no fixed lease payments. Lease payments are 5% of annual sales.

The lessee demonstrated to the lessor in negotiating the contract that it generates at least $125.000 per annum at each location, and on average, $150.000.

Solution 2

Although there is a high degree of certainty that the lessee will incur a lease expense of at least $6.250 ($125.000 * 5%) per annum, variable lease payments that are linked to the future performance or use of an underlying asset are excluded from the definition of lease payments.

Consequently, no liability is recognized for those variable lease payments.