The term minimum lease payment refers to the lowest possible payments a lessee is obligated to make in connection with an asset over the term of an agreement. Minimum lease payments can include rent, residual value, penalties, as well as a bargain-purchase option.
Minimum Lease Payment = Rental Payments + Residual Value + Renewal Penalty + Bargain Purchase Option - Executory Costs
Each of the above costs is described in more detail in the sections below.
Companies oftentimes enter into contractual agreements that include the right to use specific property. Since the terms and conditions of these contracts will vary, the Financial Accounting Standards Board issued FAS No. 13 - Accounting for Leases, which outlines the criteria used to determine if the agreement should be treated as a capital versus operating lease.
The concept of a minimum lease payment is an important variable used in the recovery of investment test (90% test), which is used to determine if an agreement should be treated as an operating or capital lease. As part of this test, the present value of the agreement's minimum lease payment is calculated. Generally, the components of an agreement's minimum lease payment consist of:
operating lease, capital lease, bargain-purchase option test, transfer of ownership test, economic life test, economic life, recovery of investment test, economic life test, economic life, executory costs, guaranteed residual value, unguaranteed residual value