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Lease classification

Definition from ASC 842 Glossary

Variable Lease Payments: Payments made by a lessee to a lessor for the right to use an underlying
asset that vary because of changes in facts or circumstances occurring after the commencement date,
other than the passage of time.

ASU 2016-02 BC205
Some or all of the lease payments for the right to use an asset can be variable. That variability can arise
because lease payments are linked to:

a. Price changes due to changes in an external market rate or the value of an index. For example,
lease payments might be adjusted for changes in a benchmark interest rate or the Consumer Price
Index.

b. The lessee’s performance derived from the underlying asset. For example, a lease of retail property
may specify that lease payments are based on a specified percentage of sales made from that
property.

c. The use of the underlying asset. For example, a car lease may require the lessee to make additional
lease payments if the lessee exceeds a specified mileage.

Variable lease payments that depend on an index or a rate should be included in the calculation of
lease payments when classifying a lease and in the measurement of the lease liability. Variable lease
payments that depend on an index or a rate meet the definition of an asset (for the lessor) and a
liability (for the lessee) because they are unavoidable and therefore economically similar to fixed lease
payments. At lease commencement, the lessor has a present right to receive those payments and the
lessee has a present obligation to make those payments. As such, the only uncertainty associated with
variable lease payments that depend on an index or a rate relates to the measurement of the asset or
liability that arises from those payments and not the existence of the asset or liability. Variable lease
payments should be calculated at lease commencement, using the index or rate at lease
commencement; no increases or decreases to future lease payments during the lease term should be
assumed.

Variable lease payments other than those that depend on an index or a rate should not be included in
lease payments for purposes of classification and measurement of the lease, unless those payments are
in substance fixed lease payments.

If a lease includes a renewal option that the lessee is reasonably certain to exercise and the payments
during the renewal period are based on the fair market rents at the beginning of the renewal period,
we believe the renewal period rents should be treated similar to variable lease payments that depend
on an index or rate. This approach is consistent with paragraph 28 of IFRS 16, Leases, which says that
variable lease payments that depend on an index or rate include payments that vary to reflect changes
in market rental rates.

Subsequent to the lease commencement date, when the actual payments in the renewal period are
known, the lessee would not remeasure the lease payments. Rather, any changes would be a period
cost during the period in which they are incurred. The lessor would record the changes as earned
during the period they occur.

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