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Lease classification

Leases that commence at or near the end of the underlying asset’s economic life are exempt from
applying this particular lease classification criterion. When determining if a lease has commenced at or
near the end of the underlying asset’s economic life, use to date and the remaining economic life of the
underlying asset at lease commencement should be considered. The FASB has indicated that one
reasonable approach to determining the applicability of this exception is to conclude that a lease that
commences in the final 25% of an asset’s economic life is at or near the end of the underlying asset’s
economic life.

See LG 3.3.3.2 for additional information on determining the estimated economic life of a leased asset.

3.3.3.1 Determining the term of the lease

Leases often include options to either extend the term of the lease (commonly referred to as a “renewal
option”) or to terminate the lease prior to the contractual lease expiration date (commonly referred to
as a “termination option”).

As discussed in ASC 842-10-30-1, a lessee or lessor should consider all relevant contractual provisions,
including renewal and termination options, to determine the term of the lease. Only renewal or
termination options that are reasonably certain of exercise by the lessee should be included in the
lease term. Additionally, if a renewal option is controlled by the lessor, the lessee and lessor must
include that renewal period in determining the lease term.

ASC 842-10-30-1

An entity shall determine the lease term as the noncancellable period of the lease, together with all of
the following:

a. Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that
option

b. Periods covered by an option to terminate the lease if the lessee is reasonably certain not to
exercise that option

c. Periods covered by an option to extend (or not to terminate) the lease in which exercise of the
option is controlled by the lessor.

Unlike a renewal option controlled by the lessor, periods covered by a renewal option controlled or
effectively controlled by a third party may or may not be included in the lease term. Judgment must be
applied to determine whether an option controlled or effectively controlled by a third party should be
reflected in the lease term.

The assessment of whether it is reasonably certain that a lessee will exercise an option should be based
on the facts and circumstances at lease commencement. The assessment should not be based solely on
the lessee’s intentions, past practices, or estimates. It should focus on the factors that create an
economic incentive for the lessee, including contract-, asset-, entity-, or market-based factors.

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