Transcription:

Welcome to Index-Based Payments training with VLU. This course covers the proper handling of CPI or other indexed lease payments in Visual Lease.

By the end of this course, learners should be able to:

• Explain the most common index-based payment arrangements and how they differ under new accounting standards.
• Create financial entries to support future index-based payments.
• Apply actual increase amounts at the proper time.
• Determine when a remeasurement of lease liability is needed.

Please pause here to take a moment to review the agenda.  If you are looking for a specific topic, feel free to navigate to the corresponding timestamp.

This video provides an overview of the most common index-based payments and how they are handled under the current standards. It is common practice for leases to include terms for index-based increases.

These increases are addressed in any number of ways, the most common being:

• Predetermined increase is clearly defined in the lease terms.
• Variable index-based rate increase (either an inflation index like the CPI in the United States, or a variable interest rate payment like SOFR plus 150 basis points.)
• Combination of predetermined and index-based rates; minimum required “floor” increases in conjunction with CPI rates.

This course will focus on the variable payment scenarios and the process for clients reporting FASB 842, GASB 87 or IFRS 16 standards.

Under previous standards, specifically ASC 840, CPI increases were typically configured as planned increases under the primary base rent entry.

The increase was then applied to the schedule as an increase in the cash payment since liability was not captured.

While this process seems easier to some and contains all base rent expense under a single entry, it is not advisable under ASC 842 and would result in an overstated liability.

FASB guidance of ASC 842 states that CPI based changes to lease payments be treated as Variable Payments.  Variable expenses are not factored into the lease liability, unless a remeasurement is required for other reasons.

GASB 87 also requires CPI increases be treated as Variable Payments

The IFRS 16 standard requires after each time a lease changes, the amount must be factored into the total lease liability by treating it as a regular lease payment.

The VL platform can be easily configured to support organizations reporting under any of these standards to easily apply both treatment types.

This video outlines the process of configuring a placeholder entry to support a variable payment for CPI increase.

Regardless of the standard, the initial configuration of the financial entry is much the same.  Visual Lease recommends this configuration based on its ability to support reporting under FASB 842, GASB 87 and IFRS 16 standards and avoid deleting and re-entering data if reporting requirements change.

Begin on the Entries section of the Financials tab and click Add Record to create a new financial entry.

It is recommended that this entry be categorized the same as your base rent expense.  While this is not a requirement, doing so will ensure the proper configuration for any potential future remeasurements and appropriately categorize the variable payment in your accounting feed.

Since the Financial Type field is set to “payable” you will have to select a party from the payment to drop-down. When selecting Receivable as the financial type, this section will switch to Payment From. You will still need to make a selection in this field regardless the payment type selected.

Choose the payment frequency, in this case monthly.

The start date will default to the commencement of the lease.  This should be updated to reflect the date of the first anticipated increase.  For annual increases, set the date to 1 year after the commencement.

Since the increase has not yet taken effect, and further still, we are unsure of the actual increase amount, the amount of this entry will be initially set up as 0.

If you choose to follow our recommendation that the expense category match that of the primary rent expense, you will need to select Show Optional Fields and then select the checkbox for Overlap other entries for this category in the Record Options field to overlap the entries.  By default, the platform restricts multiple expenses sharing a single category.  This is meant to avoid confusion within the accounting feed.  Leaving this box unchecked would result in the existing financial entry for this lease and Category to be ended.

Next, make your disclosure elections.  These elections are especially important to ensure the proper treatment is applied for each standard.

If you are reporting on FASB 842, select Show Optional Fields and then select FASB 842 in the “variable payment for disclosure” checkbox to ensure the entry is treated as a variable payment.

If you are reporting on IFRS 16, leave this checkbox blank – so that the entry is treated as a regular expense.

For GASB 87, select “Variable Payment” – from the “GASB 87 Payment Types for Disclosure” dropdown list.

To distinguish between this variable entry and the base rent entry, I will add a comment, here.

Finally, add planned increases for each subsequent year of the lease term by clicking the Add Increase button.

Enter the date of the next increase.

Select whether it repeats monthly or annually. If it does not repeat, leave the section blank.

Set the amount to fixed, enter the amount as 0 and add a comment if you choose.

Click Save to finalize the entry.

In this video we’ll review the steps to apply the actual amount of a CPI increase once the rate is determined.

Once the CPI amount is determined and the lessor provides notice of the total amount, return to the CPI placeholder financial entry, click the kebab and then click Edit.

Please note, that there are two entries listed now. The Initial base rent entry and the variable one we just completed.

Navigate to the amount field and enter the fixed increase amount.  Once saved, each of the planned increases will update to reflect the new dollar amount.

Return to this entry each subsequent year and edit the planned increase that corresponds with the current year, or whatever frequency you have elected.  Lease alerts can be used to help you manage your increase dates.

Enter the difference between the current rate and the new rate in the planned increase fixed amount field for each year.

For example, my initial CPI increase was $200 in 2021, the following year it increased to $355.  This is a difference of $155, which is what I will enter into the fixed amount field for 2022, bringing the total amount to $355.

In this video, we will review the recommended steps to apply a CPI floor to a lease record.

A less common, yet still prevalent practice, is to include a floor rate for CPI Increases.  The floor is the fixed “no less than” rate that is applied each period, regardless of the actual CPI rate.  Unlike a traditional CPI with no floor, the minimum required increase must be accounted for in the liability schedule.

To begin, it is recommended that the floor rate be built into the initial base rent expense financial entry as a planned recurring increase.

Navigate to the base rent entry, then click the kebab and then click Edit.

In the planned increases section, select add increase

Enter the date of the first increase – typically 1 year from the lease commencement date, select Repeats Annually from the Does Not Repeat field and enter 1 year, select Percent in the Increase By field, enter the amount, and then add any comments as needed before saving your changes.

Click Save to close the entry and return to the entries landing page.

The next step is to calculate the actual payment amount based on the current CPI.  If the current CPI rate is greater than the minimum requirements, you must determine the delta to enter as your variable CPI increase.

For example:

A lease may stipulate a floor increase of 2% annually, or the CPI rate, whichever is greater.  In this case, the minimum increase amount will be 2% each year.  This is reflected in the Base Rent w/ Planned Increase column.

If the actual CPI rate in 2021 was 3.5%, I must determine the difference between the planned increase and the actual.

I will enter the actual rate and the applied rate into my matrix.  In this case, they are the same.  This 3.5% CPI rate results in an actual payment of 10,350 per month.

Remember that I have already accounted for a payment of 10,200 based on the minimum increase.  The difference of the actual and the planned amount is $150.  (show entry page)

I will have to edit the variable place holder by clicking here and selecting edit.

The difference of $150 is the initial value that is entered in the CPI placeholder entry within the VL platform.

Once the initial amount is entered, the planned increase section will also update to reflect the new amount.

The following year, in 2022 the actual CPI rate is 1.4%.  Since my floor rate is 2%, this is what I will enter in the applied CPI rate column.

The 2% increase brings my monthly payment to 10,557.  Again, I must determine the difference between the planned and actual payment amounts.  This time the difference is $153.

My current CPI in the platform is $150.  The difference between the current and the new CPI is $3.

This is what I will enter in the second planned increase placeholder of the CPI entry.   Notice once again that the increase is applied to the total amount for each year going forward.

This practice would continue each year of the lease.

In 2023 the rate is set at 2.25%, equating to a difference in payment of just over $182.

Again, I will take the difference of the new CPI amount and that of the previous year to identify the fixed increase amount that I will apply to the financial entry.

The formula has been applied to all years of the lease however, until the actual amounts are entered for 2024 and 2025 the CPI and Fixed Increase columns will display inaccurate numbers.

In this video, we will discuss how CPI payments are impacted by the exercising of an option.

Under FASB and GASB standards, variable CPI payments do not have to be factored into the lease liability, with some exceptions.  The most prevalent being the exercising of an option.

Should an option be exercised, the variable CPI payments to date must be included in the remeasurement calculation as part of the total lease liability.

Before exercising the option, navigate to the CPI entry on the entries tab, click the kebab in the row of the entry and then click Edit.

Uncheck the FASB 842 variable payment for disclosure reporting checkbox and save the change.

Now you may navigate to the lease accounting tab and create the modification remeasurement as usual.  Since the CPI entry is no longer flagged as a variable payment, the entry will be included in the remeasurement wizard.

Once the remeasurement is complete, create a new variable payment entry placeholder entry for any future CPI increases that occur after the modification date.

In this video we’ll review the steps to update the liability schedule once the actual CPI increase is applied.

After updating the financial entry with the actual CPI increase for the year, IFRS 16 requires that the increase amount be factored into the total lease liability.

In order to do this, a modification remeasurement is needed.

From the lease accounting section of the financials tab, go to the row of the IFRS 16 calculation to be remeasured, click the kebab, and then click Create Remeasurement Calc.

Set the remeasurement type to modification, enter the date the increase took effect, and then click Create Measurement.

Step through the remeasurement wizard as usual.  Ensure that the CPI entry is labeled a Lease Payment under the Financial Entries Treatment step and finalize the remeasurement.

The new calculation and resulting schedule will be updated to reflect the increase in total liability.

This concludes the Index Based payments course with VLU.

Remember…

• FASB & GASB clients are not required to factor variable CPI payments into lease liability.
• IFRS clients must remeasure the lease liability after each increase.
• CPI Floor requirements should be built into the primary base rent expense and therefore be factored into lease liability.
• FASB & GASB clients must factor variable CPI payments to date into the lease liability when an option is exercised, resulting in a remeasurement.

Thank you for your time.  Questions, suggestions, or feedback may be sent to support@visuallease.com