Least Lease Payments

What Are Minimum Lease Payments?

The base lease payment is the most minimal amount that a lessor can hope to make (and a lessee can hope to pay) over the lifetime of the lease. Accountants compute least lease payments to assign a current value to a lease to record the lease appropriately in the company's books.

The method of computing least lease payments is spread out in the Statement of Financial Accounting Standards No. 13 (FAS 13), Accounting for Leases, which was distributed by the Financial Accounting Standards Board (FASB) in 1980.

The Formula for Minimum Lease Payments and Lease Valuation

The current value formula incorporates the base lease payments and the value of the total lease. Leased equipment frequently has a residual value toward the finish of the lease term, which is an estimate of the amount of value staying in the leased asset.
$\begin &PV = \sum_^ \left[ \frac{\left(1+r\right)} \right] + \frac{\left(1+r\right)^n} \ &\textbf\ &PV = \text \ &Pmt_i = \text i\ &r = \text \ &n = \text \ &Res = \text \ \end$

What Does Calculating Minimum Lease Payments Tell You?

The base lease payment calculation is an important part of an accounting analysis called the recovery of investment test (90% test). This test is utilized to conclude whether a lease ought to be recorded in the company's books as a operating or capital lease. The accounting treatment for least lease payments varies, contingent upon whether you're the lessee or the lessor.

At the point when a company can't stand to completely purchase equipment or anticipates that it should have a short helpful life, it might opt to lease the equipment. The lessor claims the equipment and rents it out. The lessee makes routinely scheduled payments to the lessor for the utilization of the equipment. The lessee is expected to make a base payment during the contractual period that the equipment is leased out. The base payment is known as the base lease payment.

Least lease payments are rental payments over the lease term including the amount of any bargain purchase option, premium, and any guaranteed residual value, and excluding any rental connecting with costs to be met by the lessor and any contingent rentals.

Special Considerations

Albeit common sense recommends that the base lease payments on a year lease at $1,000 a month ought to be $12,000, this number can be confounded by contractual provisos. Executory costs like maintenance and insurance are typically excluded on the grounds that they are the responsibility of the lessor, yet different factors can be added to the cost of a lease.

These incorporate any guarantees made by the lessee to the lessor about the residual value of the leased property toward the finish of the lease as well as any payments for non-recharging of the lease. Once these are calculated in, a reasonable present value can be assigned to the lease for the purpose of accounting.

Illustration of Minimum Lease Payments and Present Value

The value of a lease is estimated by discounting the base lease payments. We should utilize a guide to determine how much a lease will cost in the present dollars. A company requires out a 3-year lease on a number of substantial trucks.

The base lease payment each month is $3,000 each month or $36,000 each year. Lessors additionally charge interest as compensation for leasing their equipment. In this case, the interest rate is 5% each year, or 5% separated by12 months = 0.417% each month.

To work out the present value (PV) of the leased trucks, the residual value must be calculated in. The residual value is the value of the trucks after the lease period is finished. How about we accept, in this case, that the residual value is $45,000.

The annual interest rate on the lease is utilized as the discount rate in working out the PV. The PV on the trucks' lease can be calculated utilizing the PV formula, and remembering the residual for the calculation, as follows:
$\begin PV =& \ \frac{ $\text{36,000} }{ 1.051 } + \frac { $\text{36,000} }{ 1.052 } + \frac {$\text{36,000} }{1.053 } + \frac { $\text{45,000} }{ 1.053 } \ =& \ $\text{34,285.71} + $\text{32,653.06} + $\text{31,098.83} +\ &\ $\text{38,873.53} \ =& \ $\text{136,911.13} \ \end$
In the present value, the lease will be estimated to cost $136,911.13.

Features

• Present value calculations are used to discount future lease payments to appropriately account for the time value of money.
• Least lease payment estimates utilize a 90% test for an asset's recovery of investment, whether or not it is a capital or operating lease.
• Least lease payments allude to the most reduced anticipated amount a lessee is expected to pay throughout the span of a leased asset or property.