Lease payments often include variable payments that depend on an index or a rate. These type of variable lease payments are included in the measurement of the lease liability. Here we respond to common questions we are hearing for lease payments that vary when there are changes in an index or a rate, such as the consumer price index (CPI), under AASB 16 Leases.
Let’s pose a scenario that a company rents office space in a building for five years. Lease payments are $200,000 per year, payable at the beginning of each year. For Years 2 to 5, lease payments are indexed annually at the beginning of the year for the change in the CPI for the preceding year.
This means that the lease payment for Year 2 is determined at the beginning of Year 2, by reference to the CPI at the commencement date. As a result of the change in CPI from commencement to the end of Year 1 the lease payment for Year 2 is determined to be $204,000.
Question 1: At commencement, is CPI estimated/forecasted for future years when calculating the lease liability?
Interpretive response: No. Variable lease payments that depend on an index or rate – such as CPI – are initially measured using the index (or rate) at the commencement date of the lease. Future changes in the index or rate are not estimated.
This means that at commencement, there is no adjustment made to future lease payments for any estimated or forecasted changes in CPI. The lease liability is measured at the present value of the annual lease payments of $200,000 per year, which would equal $709,000 [4 years x $200,000 discounted at 5 percent – as the first year is paid on commencement].
Question 2: How is the re-measurement of the lease liability recognised?
Interpretive response: The company remeasures the lease liability when the next amount payable is fixed. In this case, when the change in CPI is known at the beginning of Year 2, where the amount payable for Year 2 is determined to be $204,000.
All subsequent lease payments (Years 3 to Year 5) are also adjusted to reflect the updated payment.
As the amounts relate to Years 2 to 5, the change is recognised as an adjustment to the right-of-use (ROU) asset. That is, the resulting change in the lease liability of $14,000 [$723,000 (($204,000 – $200,000) x 4 years discounted at 5 percent) – $709,000] is adjusted against the ROU asset.
This re-measurement process is repeated at the beginning of each year when the amount payable for the next period is known.
At the commencement date, the lease payments included in the measurement of the lease liability includes variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date. [AASB 16: 27(b)]
A lessee remeasures the lease liability by discounting the revised lease payments, if there is a change in future lease payments resulting from a change in an index or a rate used to determine those payments. The lessee remeasures the lease liability to reflect those revised lease payments only when there is a change in the cash flows (ie when the adjustment to the lease payments takes effect). A lessee shall determine the revised lease payments for the remainder of the lease term based on the revised contractual payments. [AASB 16: 42(b)]
Variable lease payments based on an index or a rate include, for example, payments linked to a consumer price index, payments linked to a benchmark interest rate (such as BBSW) or payments that vary to reflect changes in market rental rates. Refer to our AASB 16 – Variable lease payments practical guide below.
If you would like to discuss the implementation of the new standard for your organisation, please contact us.
Our Practical Guide illustrates measurement of the lease liability and right-of-use asset where lease payments vary according to an index or a rate.
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