Lease payments can change from month to month
If you’ve ever entered into a lease for an apartment or anything else, you’ve probably had a fixed payment that didn’t change from month to month. But for municipalities and other organizations, it’s not uncommon to have variable payments.
These variable payments can be based on several different factors, including a rate or index, but are often based on performance. For example, a business might be required to pay a certain percentage of its revenue as a lease payment. Similarly, for a variable payment on a vehicle lease, the monthly payment could be based on the number of miles driven that month.
Example:
Suppose you’re opening a new water processing facility in your town. You find the perfect space and speak with the owner about leasing it. The lease agreement calls for a variable payment based on revenue. Each month, you must pay 10% of the revenue to the building’s owner.
For example, if you have $20,000 of revenue in a given month, your variable lease payment will be $2,000. The payment may be higher or lower during certain months.
Variable payments can be more difficult for accounting purposes since a lessee doesn’t necessarily know what their lease payment will be from one month to the next. Often lease agreements that use variable payments based on performance still have a minimum payment.
In the example of our water treatment facility above, the lease agreement might state that the town will pay 10% of revenue or $1,500, whichever is higher. While this could result in a disproportionately high payment during some months, it also makes it easier to make accounting projections since the lessee knows the minimum it must pay. If there is a rent floor that can be determined, this is the value that will be used to determine your lease liability or asset. If the rent is solely variable based on future performance, the agreement would not qualify for GASB 87, as it has no fixed or fixed in substance payments (solely variable).
What’s important here?
A variable lease payment can be used on future performance, such as a company’s revenue or usage. In this case, the payment could change from month to month. Due to this, if an agreement does not include a payment minimum or price floor, having solely variable payments will disqualify the agreement from GASB 87.
