Variable payments can change based on a benchmark index
Lessors and lessees must agree on certain payment terms. Payments in certain leases remain fixed throughout the entire lease, while others can vary.
When a lease has a variable payment based on an index, the payment can change over time based on a specific benchmark, such as the Consumer Price Index (CPI), London Interbank Offered Rate (LIBOR), or fair market rents. The initial payment amount is based on the index at the commencement of the lease and can fluctuate with the benchmark. Generally speaking, leases will stipulate how often the payment will change based on changes in the index.
Example:
Suppose your organization is entering into a lease with a variable payment based on the Consumer Price Index (CPI). You have a five-year lease, and the contract states that once per year, your payments will change along with changes in the CPI. While the CPI may change more often, your payment won’t. If the CPI has increased since the previous year, your payment will go up. On the other hand, if the CPI has decreased, your payment will go down.
For planning and accounting purposes, you’ll use the payment at the commencement of the lease to include in the lease liability. If your payments change in the future, you’ll treat that adjustment as a variable lease expense. Additionally, the amount your payment will change depends on the index upon which it’s based.
What’s important here?
When you have a lease with a variable payment based on an index, you can feel confident your payment will change at some point. Unfortunately, you can’t know ahead of time whether your payment will increase or decrease.
