Lease contracts have multiple components that range from base rent payments, common area maintenance, taxes, and/or insurance. These payments can be fixed or variable. When it comes to variable payments, ASC 842 has different ways of accounting for these payments. What are variable payments, when should they be allocated, and how should they be allocated?
What are variable payments?
Variable lease payments are generally classified as either index or non-index based.
Index lease payments- As stated in ASC 842-10-30-5, lease payments include variable lease payments that depend on an index or rate (such as Consumer Price Index or a market interest rate), initially measured using the index or rate at commencement date. Index based variable payments should only remeasure variable lease payments and lease liability when there is a subsequent measurement of lease payments based on ASC 842-10-35-4
Non-Index lease payments- As stated in ASC 842-10-30-6, lease payments should exclude variable lease payments that do not depend on an index or rate. Examples of variable non-index payments include reimbursement of variable CAM, tax, or insurance fees to the lessor.
Note: Payments that depend on a lessee’s performance or use of the underlying asset are also excluded from the lease payments. Performance based variable payments are contingent on future events and do not represent a current obligation to the lessee. Examples of this could be payments related based on the percentage of sales produced from a leased store.
As you can see in most cases index and non-index payments should not be included in lease payments or when measuring the lease liability and ROU asset. ASC 842-10-15-31 states all lease components to be separated between lease and non-lease payments unless the non-separation practical expedient is elected (842-10-15-37). Since variable payments are not included in the lease payments, they need to be allocated to non-lease payments and expensed separately.
How to allocate variable lease payments?
Practical Expedient- When using the practical expedient noted in ASC 842-10-15-37, the lessee may combine lease payments and non-lease payments into a single lease payment. The single lease payment will be used to calculate the measurement and remeasurement of lease liability and ROU asset.
Non-lease payment allocation- Lease payments do not include amounts allocated to non-lease components and should not be used to calculate lease payments. When a non-lease component has been identified in accordance with ASC 842-10-15-30, an allocation of the total consideration in the contract is applied to lease and non-lease payments.
- Stand-alone pricing- If the contract states stand-alone prices for the amounts of the lease and non-lease components, that amount is used for allocation. For example, a contract states $100 is to be paid for the right to use leased building and a monthly reimbursement payment of CAM charges incurred by the lessor. In this case the $100 is allocated to lease payments and the variable cost of CAM is allocated to non-lease payments.
- Allocation estimation- If the lease contract bundles lease and non-lease components, an estimation should be used for the allocation between the two payments. For example, the contract states $150 is to be paid monthly for the right to use leased building and CAM charges. In this case the lessee can estimate the lease and non-lease payment amounts based on similar comparables to facts and circumstances. They may determine that $100 goes to lease payments and $25 goes to non-lease payments. Any other separate non-lease payments or non-component payments would be allocated to the non-lease component ratio .16 (25/150).
NetLease makes the process of adding non-lease payments to your schedule simple and easy whether those payments are variable or fixed. If the payment is fixed you can simply add the non-lease payment amount alongside the lease payment for the period it is expensed. NetLease gives the ability to name your non-lease payment and to expense it directly in the NetLease monthly journals.
When non-lease payments are variable and need to be updated, NetLease makes it easy to update the non-lease payments on monthly or any other recurring basis. The user can simply adjust the non-lease payment schedule through Non-Lease Payment modification.
All in all, there is a reasonable amount of consideration that the lessee should take when trying to identify and allocate variable payments. In more cases than not any variable payments related to a lease contract should not be included in lease payments used to measure the lease liability and ROU asset. Separating and allocating lease from non-lease components may appear to be tedious, but the guidance provides a simple and less costly option through the practical expedient. If lease and non-lease payments are separated, it is always best to use the prices that are explicitly stated in the contract as stand-alone prices and to use quality comparable when determining the various allocations.