Lessee lease classification

Lessee lease classification determines whether subsequent accounting follows the finance or operating model. The decision occurs at commencement after the term, payments, rate, and underlying-asset facts are established.

Evaluate all five criteria

A lease is a finance lease when any one of five criteria is met:

1. Ownership transfers by the end of the lease term.
2. A purchase option is reasonably certain to be exercised.
3. The lease term covers a major part of the asset's remaining economic life.
4. Payments plus the applicable residual guarantee represent substantially all fair value.
5. The asset is so specialized that the lessor expects no alternative use.

If none applies, the lessee classifies the lease as operating.

Suppose a production line lease covers 72 percent of remaining life and payment present value is 89 percent of fair value. Those figures do not automatically require operating classification. A specialized design with no expected alternative use could meet another criterion. Percentage conventions may support a consistent policy, but Topic 842 does not make 75 and 90 percent mandatory bright lines.

Classification changes expense and cash-flow patterns. Outside a qualifying short-term election, it does not remove the right-of-use asset or liability. Read the criteria in ASC 842-10-25-2 and the operating result in ASC 842-10-25-3.