Your monthly lease payments aren’t your only lease liability
Several types of payments are accounted for in the initial lease liability measurement. These might include fixed payments, residual value guarantees, purchase options you are reasonably certain to exercise, termination penalties, and other reasonably certain payments. Relevant factors that can help determine if a payment is reasonably certain include market-based, contract-based, asset-based, and government-specific factors.
Example:
Suppose your municipality is entering into a lease. The lease agreement calls for fixed monthly payments of $2,000 per month. When you’re budgeting the costs of the lease, it’s easy to only consider those monthly payments.
But for accounting purposes, it’s important to consider the other expenses you might be subject to, including residual value guarantees, purchase options, termination penalties, and other reasonably certain payments.
What’s important here?
Relevant factors in determining whether other payments are considered “reasonably certain” include:
- Market-based factors: A changing market environment could make contract terms and conditions for the optional periods more or less favorable compared to current market rates.
- Contract-based factors: These are factors relevant to the lease agreement. For example, economic deterrents, such as costs to terminate an existing lease and sign a new one, could impact whether payments are reasonably certain. These contract-based costs can include negotiation, relocation, identifying another underlying asset for the contract, returning the underlying asset in a condition or to a location specified in the contract, or a substantial cancellation penalty.
- Asset-based factors: These are factors relevant to the underlying asset. For example, as whether the asset underlying the lease is necessary for providing government services.
- Government-specific factors: These are relevant to the government entities that are parties in the contract. They could include the cost or timeliness of a government’s procurement process or the likelihood that the government will appropriate funds based on experience.
