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?
- Variable lease payments are classified as either index or non-index based
- Variable payments should not be included in lease payments or when measuring the lease liability and ROU assets
- When allocating variable lease payments, practical expedient, stand-alone pricing, or allocation estimation can be used
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.
How are variable lease payments treated in accounting?
Variable lease payments are treated differently depending on the type of lease. For operating leases, variable lease payments are generally recognized as expenses in the period in which they are incurred.
For finance leases, variable lease payments are treated as part of the lease liability and recognized as interest expense over the term of the lease.
What are variable lease payments under IFRS 16?
Under IFRS 16, variable lease payments are defined as payments that are not fixed in amount and are dependent on a future event or factor other than the passage of time, such as the usage of the leased asset.
These variable lease payments can include payments based on a percentage of sales, usage or productivity thresholds, or changes in market prices, among other factors.
Are variable lease payments included in lease liability?
Yes, variable lease payments are required to be included in the lease liability and right-of-use asset–either initially if their amount can be determined at the commencement date, or subsequently when the event or factor on which they depend occurs.
What does fix mean in loans?
In loans, "fix" usually refers to a fixed interest rate. A fixed interest rate is an interest rate that remains the same throughout the life of the loan. This means that the borrower will pay the same amount of interest each month, making it easier to budget and plan for loan payments.
Which is better: fixed or variable rate?
It depends on your individual situation. A fixed-rate provides certainty and stability with the same interest rate for the entire loan term, while a variable rate fluctuates based on market conditions, which could mean lower payments when rates are low, but higher payments when rates rise.
It is important to carefully consider factors such as loan terms, market trends, and individual financial situations when choosing between fixed and variable interest rates.
What is the difference between variable and fixed loans?
The main difference between variable and fixed loans is the interest rate. With a fixed loan, the interest rate remains the same for the entire duration of the loan, whereas with a variable loan, the interest rate can change over time based on market conditions.
Fixed loans give the borrower the security of knowing exactly how much they will need to pay each month. In contrast, variable loans may offer lower initial interest rates but come with the risk of rates increasing in the future. The choice between a fixed or variable loan depends on the borrower's individual circumstances and risk tolerance.
What is an example of a variable rate?
An example of a variable rate is an adjustable rate mortgage (ARM) where the interest rate can change periodically based on a specified index. Another example of a variable rate is a credit card where the interest rate can fluctuate based on market conditions or other factors.
What is a variable rate transaction?
A variable rate transaction refers to a financial agreement in which an asset's interest rate or price is subject to change, based on a predetermined index or benchmark. This means that the rate or price can increase or decrease over time, depending on changes in the market or economy.
Why would you use Direct Debit for variable payments?
Direct Debit is a payment method that allows a company or organization to collect varying amounts from a customer's bank account. Direct Debit is useful for variable payments because it eliminates the need for the customer to manually initiate payment each time, reducing the risk of late or missed payments.
Instead, the company can automatically collect the correct payment amount regularly, which helps ensure timely and accurate payment processing.
What other payment methods could you use?
Aside from Direct Debit, businesses can use other payment methods for variable payments. Standing orders are suitable for regular fixed payments and electronic funds transfer (EFT) can be used for payments scheduled to occur at regular intervals. Credit cards are also ideal for varying purchases of goods and services.
Payment apps like PayPal, Venmo, and Cash App allow users to send and receive payments quickly and easily from their mobile devices. The best option will depend on the business's and its customers' needs.