Tax Law and News Changes Ahead for Lessors With the New Lease Standards Read the Article Open Share Drawer Share this:Click to share on Twitter (Opens in new window)Click to share on Facebook (Opens in new window)Click to share on LinkedIn (Opens in new window) Written by Liz Farr, CPA Modified Aug 8, 2019 4 min read FASB’s latest guidance for lease accounting for lessors, as codified in ASC 842, looks nearly identical to the previous guidance, ASC 840. Lessors still have three categories of leases: operating leases, sales-type leases and financing leases. For sales-type leases and financing leases, lessors still recognize a lease receivable and remove the related asset from their balance sheet. For operating leases, lessors will still keep the leased asset on their books and depreciate it. Over on the income statement, lessors still recognize depreciation and rental income for operating leases. Sales-type leases and financing leases still recognize selling profit or loss at commencement, and interest income as payments are received. The substantive changes come in the ways that leases are split between the three categories. The former “bright line” tests for classifying a lease as a capital lease are replaced with new criteria. Under the old criteria, a lease qualified as a capital lease if the lease term was 75 percent or more of the expected economic life of the asset, or if the present value of the lease payments equaled 90 percent or more of the fair value of the asset. The new tests omit those definite numbers and require more judgment on the part of the lessor for correct classification. Sales-Type Lease Criteria Under ASC 842, lessors will classify a lease as a sales-type lease if any of the following five criteria are true. These are the same criteria that lessees will use to classify a lease as a financing lease: Ownership is transferred to the lessee by the end of the lease term. The lease contains a purchase option which the lessee is reasonably certain to exercise. The lease term is for the major part of the remaining economic life of the underlying asset. But, if the lease begins at or near the end of the economic life of the asset, this criterion does not apply. The present value of the future minimum lease payments, plus the present value of any residual value guaranteed by the lessee that isn’t already reflected in the lease payments, equals or exceeds substantially all of the fair value of the underlying asset. The underlying asset has such a specialized nature that the lessor is not expected to have any alternative use for it at the end of the lease term. Operating Lease vs. Financing Lease Criteria If none of these are true, the lease is either an operating lease or a financing lease. If the following two criteria are true, the lease is a financing lease: The present value of the future minimum lease payments, plus the present value of any residual value guaranteed by the lessee or an unrelated third party that is not already reflected in the lease payments, equals or exceeds substantially all of the fair value of the underlying asset. It is probable that the lessor will collect the lease payments, plus any amount due under a residual value guarantee. Here, the crucial factor is that an unrelated third party will provide any residual value guaranteed. Without that type of guarantee, the lease is an operating lease. Real Estate Leases are Different Under ASC 840, leases of real estate were only classified as sales-type leases if title was explicitly transferred to the lessee at some point during the lease term. This requirement has been removed from ASC 842, so lessors of real estate may be spending more time evaluating the classification of their leases. Collectability is no Longer a Criteria ASC 840 required that collectability of lease payments be reasonably predictable for sales-type leases, but the new guidance does not mention collectability as a criterion for classification. This may mean that more leases will be classified as sales-type leases. Revenue Recognition Tied in to the Lease Standards Because the new lease standards are coming out just after the FASB’s new revenue recognition standard, ASC 842 directly references ASC 606 when appropriate. For example, lessors are directed to apply the guidance in ASC 606 when leases have non-lease components. These differences mean that lessors, as well as lessees, will need to take a closer look at their leases when it’s time to implement ASC 842, so advisors need to be aware of these changes. Public companies will start implementing this in 2019, while non-public companies have another year. For more details on the lease standards, Deloitte has a great, easy-to-understand guide you can download here. Editor’s note: This article originally published on the Firm of the Future blog. Previous Post Tax Planning for Multi-Level Marketers Next Post Tax Reform Brings Changes to Qualified Moving Expenses Written by Liz Farr, CPA Liz has been a CPA since 2005 and spent 15 years working as an accountant with a focus on tax work. She also worked on audits, business valuations, and litigation support. Since 2018, she’s been a full-time freelance writer, and has written articles on technical accounting topics, blog posts, case studies, white papers, web content, and full-length books for accountants and bookkeepers around the world. Her current specialty is ghostwriting for thought leaders in accounting. More from Liz Farr, CPA Comments are closed. 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