Question

Larkspur Fashion Company enters into a lease arrangement with Highpoint Leasing for 5 years. Larkspur agrees to pay 5% of its net sales as a variable lease payment. Larkspur does not pay any fixed payments. Larkspur is a highly successful company that has achieved over $1,750,000 in net sales over the last 7 years. Both Larkspur and Highpoint forecast that net sales will be a much greater amount than $1,750,000 in subsequent years. As a result, it is highly certain that Larkspur will make payments of at least $87,500 ($1,750,000 × 5%) each year.

What is the lease payment amount Larkspur should use to record its right-of-use asset?

Answer 1

Solution:

Right-of use-asset, variable lease payments depending on the future sales are not centain. Althoght there is past experience to achieve sales but is is not the guarantee of future sales.

In other words they are excluded from lease payments. Instead, they are booked in the profit and loss when they incurred.

Reason for such exclusion is that estimation of the future sales would very high level of uncertain. we can centain sales when contract for sale exists.

For example: Due to covid 19, In current year some of companies have zero turnover even their past record are good.

Right-of-use-asset = NIL

Lease Payment = Charged to Income statement directly