# Lease Payments

Lease payments represent the consideration for the underlying asset in a lease. It includes fixed payments, variable payments linked with an index or rate and payments/penalties contingent upon exercise of extension/termination options.

While IAS 17 used the term 'minimum lease payments', IFRS 16 relabels the lease consideration as 'lease payments' and includes variable payments linked to an index or rate which where earlier included in contingent rent.

Even though most of the components of lease payments are same for both lessee and lessor, some differences exist due to extension/termination options, penalties, and residual value guarantees.

## Components of lease payments

Lease payments mainly comprise of:

• Fixed payments (including in-substance fixed payments) less any lease incentives;
• Variable lease payments that depend on an index or rate;
• Exercise price of the purchase option if the lessee is reasonably certain to exercise it; and
• Penalties due on termination of lease if the lessee is reasonably certain to terminate.

Further, in case of lessee it includes residual value guaranteed by him, but in case of a lessor, it includes residual value guaranteed by either the lessee, a party related to the lessee or any unrelated party if they are reasonably certain to discharge such guarantee.

Variable lease payments are those which vary after the commencement date due to reasons other than the passage of time. Any payments which are not variable payments are called fixed lease payments. In-substance lease payments are those which even though variable in their structure are fixed in their essence. For example, they are variable only on occurrence of an event whose chances are remote.

## Example

Bebbanburg, Inc. has rented out a ship from Uhtred, Inc. on a 10-year lease against monthly lease payments. The consideration includes:

• Fixed monthly payment of $300,000; • Payment of$200,000 which will vary with the consumer price index,
• 5% of the total revenues earned using the ship during a period.

At the end of the 10-year period, Bebbanburg would have an option to extend the lease for another term of 10 years at the end of which it can acquire the ship for $10 million. If the lessee's incremental borrowing rate is 12%, let's determine the lease payments and lease liability. Lease payments shall include the fixed payment of$300,000 plus the variable payments of $200,000. These payments shall be considered for the whole 20-year period because the extension option is certain to be exercised. At the end of the 20-year lease term, there would a bullet payment of$100 million on account of purchase option. The variable payments based on 5% of revenue would not qualify for inclusion in lease payments because these are not linked to any index or rate. These shall be reflected in the period in which they are due.

Lease liability and right of use asset of \$46.3 million shall be recognized at the commencement date.

$$\text{Lease Liability}\ \\= \text{\500,000}\times\frac{\text{1}-(\text{1}+\text{1%})^{-\text{12}\times\text{20}}}{\text{1%}}+\frac{\text{\10,000,000}}{(\text{1}+\text{1%})^{\text{12}\times\text{20}}}\\=\text{\46,327,767}$$