While lessor lease classification is similar to lessee classification, there are important differences for both the old and new lease accounting standards.
Valid classifications for lessor leases:
ASC 842: Finance/Sales Type, Finance/ Direct Financing, Operating
IFRS 16: Finance, Operating
GASB 87: Finance/ Sales Type, Short Term
Required fields for classification
To determine the classification of a lease (whether it is finance or operating), several items of information are needed. The following sections describe how to determine what to enter into EZLease on the lease record:
ASC 842 classification
Lessor leases use the same tests as lessee leases (842-10-25-2). A lessor lease is considered a sales-type lease if it meets any of the following criteria:
(a) The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
(b) The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
(c) The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purposes of classifying the lease.
(d) The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments in accordance with paragraph 842-10-30-5(f) equals or exceeds substantially all of the fair value of the underlying asset.
(e) The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
If the lease meets none of these criteria, but it does meet criterion (d) if a third party residual guarantee is included, the lease is considered a direct financing lease. If it still meets none of the criteria, the lease is considered operating.
The implicit rate used to determine criterion (d) is the rate which makes the present value of the rent plus the expected residual value (whether guaranteed or unguaranteed) equal to the fair value of the underlying asset at inception. However, if the lease is direct financing and the cost or carrying amount is different from the fair value, the discount rate used for the lease is a recalculated implicit rate including the initial direct costs (which effectively causes the initial direct costs to be amortized over the life of the lease, rather than expensed at inception).
Lessor classification is similar to ASC 842, except that the direct financing classification does not exist, and a lease that meets one of the criteria is called finance rather than sales-type.
Lessor classification mirrors lessee classification, with all leases considered finance unless they are short term.
ASC 840 (FAS 13)
The criteria for determining whether a lease is capital or operating are:
- The lease transfers ownership of the property to the lessee by the end of the lease term.
- The lease contains a bargain purchase option.
- The lease term is equal to 75 percent or more of the estimated economic life of the leased property.
- The present value at the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor, including any profit thereon, equals or exceeds 90 percent of the excess of the fair value of the leased property to the lessor at the inception of the lease over any related investment tax credit retained by the lessor and expected to be realized by him.
Criteria (c) and (d) are skipped if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property, including earlier years of use.
In addition, the lease must meet both of the following criteria to be capitalized:
- Collectibility of the minimum lease payments is reasonably predictable.
- No important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease.
If a lease is considered capital according to the above criteria, it is further classified as sales-type if the cost or carrying amount is different from the fair value; otherwise, it is classified as direct financing.
Lessor classification for IAS 17 is essentially identical to IFRS 16.
Government lease accounting before GASB 87 used the same classification standards as ASC 840.