Fixed vs Variable Lease Payments: ASC 842 Lease Accounting
The guide explains that under ASC 842 lease accounting, fixed lease payments are predetermined and consistent or escalating amounts known at lease commencement, while variable lease payments fluctuate based on future events or indices, with only fixed and predictable variable payments included in the initial lease liability calculation, illustrated by an example of a retail store lease where initial payments are fixed but subsequent payments vary based on sales.
When it comes to fixed and variable lease payments, ASC 842 can make things a little sticky. There are situations where fixed lease payments become variable, then other situations where variable lease payments become fixed, and it can all end up downright confusing in the end. This guide aims to clear up some of the fog around these two types of lease payments to improve your lease accounting and ensure accurate journal entries.
What is a Fixed Lease Payment?
Fixed lease payments are payments in a lease that are made throughout the term. They can be escalating or flat for the whole term of the lease, but regardless, the parameters of a fixed lease payment as stated in the lease do not change. In other words, it is perfectly clear from the point of commencement exactly how a fixed lease payment will behave over the course of a lease.
Variable payments that depend on an index or rate are lease payments and are included in the calculation of the Lease Liability. Variable payments that depend on an index or rate fall under the category of Lease Payments because the rate can be used to predict the future of the lease. If the rate changes later, the difference would be considered a variable payment as well.
What is a Variable Lease Payment?
A variable lease payment changes throughout the term of a lease based on facts or circumstances that occur after commencement.
Variable Lease Payment ASC 842 Example
Let’s say there’s a 10 year lease on a retail store. The first year’s payments are $1,000 a month, and the remaining payments are based on a percentage of the sales made in the first year. At commencement, the amount of the payments for the last nine years of the lease is unknown and considered variable, so when determining the Lease Liability for the lease, only the payments known at commencement are included. This amount would be $1,000 per month for 12 months. At the end of the first year, when the sales numbers are known, the lessee will process a re-measurement of the Lease Liability to include the rent amount for the remaining years using the percent of sales.
What is the Relationship Between Fixed and Variable Lease Payments and Security Deposits?
Some variable payments will always remain variable, but some become fixed. Variable payments may represent a change in facts or circumstances for a lessee, whereas fixed lease payments remain constant throughout the course of a lease.
Security deposits are only a part of lease accounting if they are non-refundable.
Are Security Deposits Included in ASC 842?
Security deposits are only a part of lease accounting if they are non-refundable. However, if a lessor keeps a part or all of a security deposit due to damage the lessee caused, then the lessee records an expense for the damage and cash for the money they got back, offsetting the security deposit account in total. If a lessee receives a refunded security deposit, they record the whole amount as a debit to cash and a credit to the security deposit account.
Lease Accounting Software for Leases with Fixed and/or Variable Lease Payments ASC 842
Lease accounting software can help ensure your lease accounting goes smoothly and you avoid any errors when it comes to recording fixed and variable lease payments. Such software provides a quick, compliant, and cost-effective way to avoid the pain points and error margins of spreadsheets. Many solutions offer personalized customer support from teams made up of CPAs, public accounting auditors, former FASB staff, and software developers, as well as guides, training programs, and detailed instructions to help with the toughest questions lease accounting can present.
FAQs
Are Security Deposits Included in ROU Assets?
Security deposits are only included in the Lease Liability and ROU assets if the deposit is non-refundable. Non-refundable deposits are considered lease payments.
How do you record a security deposit in accounting?
Security deposits are recorded as a credit to cash and a debit to the security deposit account, which is usually an asset for the lessee and a liability for the lessor.
Is a security deposit an intangible asset?
Security deposits are considered a tangible asset.