Variable payments can change over time
When two parties — a lessor and lessee — enter into a lease agreement, they also agree on certain payment terms.
Many leases have fixed payments, meaning the lessee pays the lessor a set amount each month throughout the lease term. However, other leases have a variable payment tied to a particular index or rate. The index or rate to which the lease payment is tied will be disclosed in the lease and could include the Consumer Price Index (CPI), London Inter-bank Offered Rate (LIBOR), Secured Overnight Financing Rate (SOFR), fair market rents, or something else.
Example:
Suppose you enter into a lease with a variable payment based on your area’s current fair market rents. When you sign the lease, your monthly rent is $2,000. However, over the next year, the fair market rent will rise 5% in your area. Per the terms of your lease, your monthly payment will also rise by 5%. This change would affect your (or your municipality’s) budgeting or accounting.
From an accounting perspective, when a lease uses variable payments based on a rate or index, they are included in the lease liability; however, when the rates change and the payment subsequently changes, the lease will not need to be restated. Any additional amount paid after the original restatement period (or when the lease began, if after FY22) is considered a variable payment that does not need to be included in the lease liability. Alternatively, when variable lease payments are based on usage or lessee revenue, the initial measurement of the lease liability does not include them.
What’s important here?
It’s important to understand whether a lease has variable payments and, if it does, to which index or rate those payments are tied. Depending on market factors, a change in the index or rate could significantly affect your monthly payment. Depending on your lease, your payment may not necessarily change each time the index or rate changes. It is important to remember that a change in payment due to a change in an index or rate does not require a remeasurement (clarified in GASB 99).
