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What Are Minimum Lease Payments?

Kenneth W. Michael Wills
Kenneth W. Michael Wills

Perspectives in the accounting for minimum lease payments differ between the lessee and the lessor. From the perspective of the lessee, such payments are figured to determine the lowest amount payable for the term of the lease. Lessors, however, need to determine the value of the lease at any given point in time, which is done by adding in and subtracting other cost factors to arrive at the minimum lease payment. Figuring those minimums is not always straight forward for either party, because aside from the actual payment structure there are other cost factors that may or may not come into play. Some of those costs are borne by the lessee, inflating the minimum lease payment, while others are borne by the lessor, eroding the value of the lease.

Typical lease payments are figured by simply dividing the total amount due for the leases at the end of the contracts, by the total number of payments to be made. The amount arrived at, however, will not provide an accurate representation of minimum lease payments. Factors that typically impact the lessee are additional contract terms, guarantees given regarding property values of the lease property at lease end, and additional compensation required if the lease is not renewed as agreed. Taking into account each of these relevant factors and knowing how the lessee plans to exercise those options will allow the lessee’s accountant to arrive at an accurate figure.

A condo lease agreement.
A condo lease agreement.

On the other hand, the same principles apply to the lessor when figuring the value of the lease at any given point in time. In addition to ascertaining how the lessee intends to exercise options related to relevant cost factors, the lessor also needs to account for all additional costs he or she incurs. Such costs incurred by the lessor may include maintenance, insurance or even taxes in some cases. Subtracting those cost factors, while figuring back in the factors borne by the lessee will allow the lessor to account for minimum lease payments. Thereafter, the lessor can use this as a starting point to determine value at any given point during the lease, and then assign that value for accounting purposes.

Regulation by the Financial Accounting Standards Board (FASB) provides documented standards that have to be followed from both perspectives when figuring minimum lease payments. Following those standards insures that both the lessee and the lessor arrive at values using standard methodologies that are understood by all accountants and managers. Determining present values, regardless of the purpose, can have a major impact of the overall accounting of a firm. Doing so accurately helps firms to avoid misconstruing financial reports or misrepresenting reasonable values for lease contracts.

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    • A condo lease agreement.
      By: JohnKwan
      A condo lease agreement.