Minimum Lease Payment
It represents the least amount that will be paid during the lease agreement. The lessee pays it to the lessor.
What Is A Minimum Lease Payment?
Minimum lease payments refer to the small amount that a lessee, an organization responsible for reimbursements for asset usage, is obligated to pay over the lease term.
Accidental rent is ignored to determine the payment amount because that will provide a consequential return.
Also, it ignores tax amounts other than the Input Tax Credit (ITC). To classify any payment under the minimum lease payments, the current value of the minimum lease payments should be equal to or more than 90 percent of the fair value of the leased property.
Furthermore, these payments undergo discounting to ascertain their present value. This involves determining the existing value of the asset for the future sum of cash.
Key Takeaways
- Minimum lease payment represents the least amount that will be paid during the lease agreement. The lessee pays it to the lessor.
- The minimum lease payments criterion is based on the traditional accounting model.
- They are the least amount that is to be paid in an agreement. They are important as they help to determine recovery of investment tests, i.e., 90% tests.
- Minimum lease payment is calculated using the formula PV = SUM[P / (1 + r)n] + [RV / (1 + r)n].
How to Calculate a Minimum Lease Payment?
Calculation of the minimum lease payment is a critical part of accounting analysis. This procedure involves comparing the asset's current value with the value at which it was bought at the time of initiating the agreement.
If its current value is more than or equal to 90% of the asset's book value, it would be classified as a capital lease.
The formula for the calculation of Minimum Lease Payment is:
PV = SUM[P / (1 + r)n] + [RV / (1 + r)n]
Where,
- PV = Present Value
- P = Annual Lease Payments
- r = Interest Rate
- n = Number of Years in the Lease Term
- RV = Residual Value
- SUM[P/(1 + r)n] = The total amount paid over the lease term, discounted for the interest rate.
Examples of Minimum lease payment
Consider a hypothetical example. CBD Company specializes in plastic manufacturing and predicts a potential rise in plastic bottle usage. The company decided to diversify its operations and expand its factory. Therefore, it signed a three-year lease agreement for a piece of land.
The lease contract requires CBD to pay $2,000 monthly for the lease term. This amounts to a total of $72,000 ($2,000 * 12 months * 3 years) over the lease term. So, this $72,000 will be the basic rent payment for the term of the agreement.
Additionally, if CBD Company chooses not to renew the lease after three years, it must pay the lessor a fee of $1,000. If CBD, due to any unforeseen events, is unable to pay the fee, there would be a penalty for failing to renew, which is also part of the minimum lease payments.
In the scenario where CBD fails to fulfill the required fees, the total minimum lease payments would amount to $73,000. This comprises the $72,000 basic rent and an additional $1,000 penalty.
Minimum lease payment Vs. Minimum rental payment?
Following is the difference between Minimum Lease Payment and Minimum Rental Payment.
| Minimum Lease Payment | Minimum Rent Payment |
|---|---|
| Minimum lease payments are reimbursed by the lessee. | Reimbursements are made by the lessee to the lessor. |
| It is also known as the lowest value of payments made. | Minimum rent is a rent that is also known as fixed rent. |
| They include rental payments, guaranteed residual value, penalties, and bargain prices. | It is the fixed sum for every year or may change every year as per the terms of the agreement. |
Minimum Lease Payment FAQs
Leases are classified as capital or operational based on risk (any future damage or debt); the reward (any possible gain) attached to them is the owner's obligation. If the ownership is transferable, it is a finance lease; if not, it is operational.
The following types of leases don’t come under Accounting Standards 19:
- Lease contracts that deal in trading or using natural resources
For example, EAD Ltd deals with diamond extraction; it has made an agreement with JCB Ltd for the support of machinery for a time span of 3 years. - Authorization agreements such as intellectual property, songs, software, etc
For example, Shamy Publishers has purchased the rights from a well-known author to publish books in physics. - Agreement made for using particular pieces of land
For example, EAD Ltd agreed to expand their factory to meet production requirements, therefore opting to lease land.
The following are the criteria that are responsible for the cancellation of cancellable leases:
- If there is any occurrence of some remote contingency
- If there is a mutual agreement with the lessor for discontinuing the contract
- If the lessee proposes a counteroffer
- Equivalent asset is available with the same lessor
- If the lessee pays an additional amount at inception, a continuation of the lease
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