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Lease classification

We believe the same conclusions would be reached in Example 3-3 and Example 3-4 if the asset was
specialized and, instead of subleasing the asset, Lessee Corp intended to use the asset to fulfill a
revenue contract with a third party. That is, Lessee Corp must evaluate whether or not it is reasonably
certain that it will use the asset to fulfill the revenue contract during the renewal periods.

3.3.3.2 Determining the estimated economic life

The ASC 842 Glossary provides the following definition of economic life.

Definition from ASC 842 Glossary
Economic Life: Either the period over which an asset is expected to be economically usable by one or
more users or the number of production or similar units expected to be obtained from an asset by one
or more users.

Determining the estimated economic life of an underlying asset may be similar to establishing the
depreciable life of an asset. Depreciable lives may therefore provide a starting point to estimate
economic lives for comparable assets. Whether an asset is owned or rented should not affect the length
of its economic life.

Determining the estimated economic life of a new asset may be easier than determining the estimated
economic life of equipment that has previously been owned or leased. A lessor or lessee should
consider the remaining life of the underlying asset at lease commencement.

Example 3-5 and Example 3-6 illustrate how to determine the estimated economic life.

EXAMPLE 3-5

Estimated economic life – economic life of a new asset (manufacturing equipment)

Lessee Corp is in the business of manufacturing electrical devices for sale in retail hardware stores.
Lessee Corp normally purchases equipment used in its manufacturing process from a third-party
original equipment manufacturer (OEM) and assigns a 15-year useful life to the manufacturing
equipment. Similar equipment must be replaced after 15 to 20 years of use (assuming normal repairs
and maintenance during the usage period), after which it is typically scrapped.

In an effort to manage cash flows, Lessee Corp enters into a 10-year arrangement with the OEM to
lease a new piece of manufacturing equipment. The new equipment is similar in nature to the
equipment Lessee Corp normally purchases; if Lessee Corp were purchasing the equipment outright, it
would assign a 15-year useful life for depreciation purposes.

What is the estimated economic life of the equipment for purposes of classifying the lease?

Analysis

Since the manufacturing equipment needs to be replaced at some point between 15 and 20 years, the
estimated economic life should fall within that range. The midpoint of the range (i.e., 17.5 years) may
be a reasonable estimate of the equipment’s economic life assuming a more precise method of
estimating the underlying asset’s economic life does not exist.

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