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Lease classification

Question 3-2

If a lessee classifies a lease as a finance lease, must the lessor do so as well?

PwC response
Generally, yes. The lessee and the lessor apply the same basic classification criteria; however,
differences in assumptions used to classify the lease (e.g., discount rate and the impact of renewal or
purchase options) could give rise to classification differences. Lessor classification may also be
impacted by factors unrelated to the lessee. For example, a lessor may obtain residual value insurance
from a third party and include that guarantee in its lease payments. This could result in the lessor
classifying the lease as a direct financing lease while the lessee classifies it as operating.

Question 3-3
Can the classification criteria be applied to a group of leased assets (i.e., a portfolio approach)?

PwC response
Yes. However, the results must not be materially different than classifying the underlying assets on an
asset by asset basis. As a result, this approach would likely only be permitted in situations where the
lease applies to a group of homogenous assets that have identical or nearly identical lease terms.

Question 3-4

Do the lease classification criteria in ASC 842-10-25-2 and ASC 842-10-25-3 apply to leases of land?

PwC response
Yes. Leases of land should be classified like any other lease; that is, evaluated based on the lease
classification criteria in ASC 842-10-25-2 and ASC 842-10-25-3. Consequently, long-term leases of
land may be classified as finance leases by lessees. As discussed in LG 3.3.4.6, lessors use the rate
implicit in the lease as the discount rate when determining lease classification. As the unguaranteed
residual value of land at expiration of a lease is considered when deriving the rate implicit in the lease,
a lessor might classify a land lease as an operating lease even if the lessee classifies it as a finance lease.

3.3.1 Transfer of ownership

A lease is classified as a finance lease by a lessee and as a sales-type lease by a lessor if ownership of
the underlying asset transfers to the lessee by the end of the lease term. This criterion is also met if the
lessee is required to pay a nominal fee for the legal transfer of ownership. However, if a lessee can
choose not to pay the nominal fee (resulting in the lessee having the option not to purchase the
underlying asset), the provision would not meet the transfer of ownership criterion because it would
be considered an option to purchase the underlying asset. See LG 3.3.2 for information on the
accounting for options to purchase the underlying asset.

It may be difficult to distinguish between a finance lease (subject to the guidance in ASC 842) and a
financed purchase (sale) of an asset (subject to the guidance of ASC 606). Under ASC 606, the transfer
of legal title to a buyer is an important indicator when determining whether an entity has transferred

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