Variable Rents—A Liability? Assume a company pays $10,000 per month plus 2% of sales ("a variable rent charge") to occupy a retail space in a mall. The lease agreement has a 3-year noncancelable term. Based on prior history in that location, the company estimates that its variable rent charge will amount to approximately $1,000 per month.

a. Using the Conceptual Framework, evaluate whether this variable rent change meets the definition of a liability.

b. Next, locate discussion in the Basis for Conclusions of ASU 2016-02 (Leases) and describe how the FASB considered this issue of whether variable rents should be included in the lease liability recognized by companies. Describe some of the history of this issue—did the Board always hold the view that variable rents should/should not be included in companies' lease obligations?

 

Answer:

a. Not a liability at the commencement of lease; a liability after the monthly sales (basis) has occurred.

b. Initially, the exposure draft suggested that Variable Lease Payments (VLPs) are included in the lease liability computation but stakeholders concerned since there is a significant amount of judgment involved. However, Topic 842 of the deliberations simplified the rules and stated that VLPs are generally not considered in the lease liability amount.

Step-by-step explanation

a.

According to the Revised Conceptual Framework (2018), a liability is defined as a present obligation of the entity to transfer an economic resource as a result of past events. In this case, the sales, which serve as the basis for the variable lease payment (VLP), has not yet occured at the commencement of the lease so the VLP does not meet the definition of a liability yet. It is recognized when the sales is achieved.

b.

The 2010 Exposure draft of the Lease Standard initially suggested that an entity would make an estimate of all variable lease payments to be made, but almost all of the stakeholders were concerned about this as it is costly to make an estimate because of the amount of judgment involved. During a redeliberation, this was one of the concerns addressed and was therefore simplified such that only those variable lease payments that depend on an index or a rate (such as the Consumer Price Index or the market rate of interest) which are readily determinable should be recognized as part of lease liability. Those that do not fall within this category are not included in the lease liability computation.

The following snips are from the Basis for Conclusions of ASU 2016-02 (Leases):

References:

https://asc.fasb.org/imageRoot/50/77977550.pdf

https://www.iasplus.com/en/news/2018/03/cf

PFA