Minimum Lease Payments

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International Accounting Standard 17 (IAS 17) defines minimum lease payments as “the payments over the lease term that the lessee is or can be required to make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with:

(a) for a lessee, any amounts guaranteed by the lessee or by a party related to the lessee; or

(b) for a lessor, any residual value guaranteed to the lessor by:

(i) the lessee;

(ii) a party related to the lessee; or

(iii) a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee”.

Leases are contracts whereby the lessor conveys to the lessee in return for payments the right to use an asset for an agreed period. The rental payments required over the lease term are called minimum lease payments. It is obvious that the minimum lease payments on a 12-month lease at $2,000 per month should be $24,000. But this number is made more complicated by the terms and conditions of the lease agreement.

For example, if the lessee or a party related to the lessee guarantees to pay an amount to the lessor, this amount will also be part of the minimum lease payments. Similarly if any residual value is guaranteed to the lessor, the amount of this residual value will also be part of the minimum lease payments. Such guarantees are usually mad by including bargain purchase options in the lease agreement.

It should be noted that the executory costs are not included in the minimum lease payments. The executory costs include expenses such as maintenance, insurance, contingent rent, and taxes incurred for the leased property by the lessor.

The calculation of minimum lease payments is important for both the lessee and the lessor; particularly in the case of finance leases. They are important for the lessee because it has to record the lease liabilities at the present value of minimum lease payments. They are important for the lessor because it has to record the investment at the present value of minimum lease payments.