On January 1, Sepe Vineyard Supply leased a truck for a five-year period, at which time possession of the truck will revert back to the lessor. Annual lease payments are $11,000 due on December 31 of each year, calculated by the lessor using a 4% discount rate. If Sepe's revenues exceed a specified amount during the lease term, Sepe will pay an additional $3,000 lease payment at the end of the lease. Sepe estimates a 70% probability of meeting the target revenue amount. What amount, if any, should be added to the right-of-use asset and lease liability under the contingent rental agreement?

Question

Quizplus · Accepted Answer

If the amounts of future lease payments are uncertain due to contingencies or otherwise, we don't consider them as part of the lease payments. There are two exceptions to not including variable payments as part of the lease payments. One is when apparent "variable" payments actually are fixed payments in disguise. These in-substance fixed payments are considered as part of the lease payments. Another exception is when variable lease payments depend on an index or a rate, the Consumer Price Index, for instance. If the amounts of future lease payments vary solely when an index or rate changes, changes in the payments are included as part of the lease payments. So, even though Sepe estimates a 70% probability of meeting the target revenue amount, we cannot include the additional payment, and no amount should be added to the right-of-use asset and lease liability under the contingent lease payment agreement.

On January 1, Sepe Vineyard Supply Leased a Truck for a Five-Year