How to Record Right-of-Use Asset for Variable Lease Payments
What is the lease payment amount Teal Mountain should use to record its right-of-use asset?
Teal Mountain Fashion Company enters into a lease arrangement with Highpoint Leasing for 5 years. Teal Mountain agrees to pay 4% of its net sales as a variable lease payment. Teal Mountain does not pay any fixed payments. Teal Mountain is a highly successful company that has achieved over $1,900,000 in net sales over the last 7 years. Both Teal Mountain and Highpoint forecast that net sales will be a much greater amount than $1,900,000 in subsequent years. As a result, it is highly certain that Teal Mountain will make payments of at least $76,000 ($1,900,000 × 4%) each year. Final answer: Teal Mountain should use the forecasted minimum payment of $76,000 to record its right-of-use asset for the lease.
The Lease Payment Amount for Right-of-Use Asset
The lease payment amount that Teal Mountain should use to record its right-of-use asset for the lease is $76,000. This figure is derived from the 4% variable lease payment arrangement based on Teal Mountain's net sales.
Explanation
When dealing with a lease agreement where the lease payment is tied to a percentage of the lessee's net sales, it is crucial to consider the forecasted minimum payment. In the case of Teal Mountain Fashion Company and Highpoint Leasing, the variable lease payment is set at 4% of Teal Mountain's net sales.
Teal Mountain's history of achieving net sales exceeding $1,900,000 over the years, combined with the anticipation of continued growth in net sales, leads to a forecasted minimum lease payment of at least $76,000 annually ($1,900,000 × 4%). This minimum expected payment should be used by Teal Mountain to record its right-of-use asset for the lease according to accounting standards.
Understanding the importance of fixed and variable costs is essential in making financial decisions related to lease agreements and overall business operations. For instance, similar considerations of costs and revenues are made in scenarios like the Yoga Center example, where profitability is assessed based on revenue exceeding variable costs.