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Lease classification

EXAMPLE 3-6

Estimated economic life – economic life of a used asset (real estate)

Lessee Corp enters into a 10-year lease with Lessor Corp for the use of a warehouse. The warehouse is
40 years old at lease commencement. Lessee Corp has purchased other warehouses and typically
depreciates them over 40 years.

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

Analysis

If Lessee Corp simply looks to the age of the warehouse, it may conclude that the building has no
further economic life. However, this is not a reasonable assumption at lease commencement given
Lessee Corp’s intent to lease the building for 10 years.

The remaining economic life of the building should be estimated based on its condition at lease
commencement and Lessee Corp’s estimate of how long the building will be usable in the future
assuming normal repairs and maintenance. The assessment should be based on the underlying asset,
not the lease term. Lessee Corp may conclude that the building has a future economic life in excess of
the 10-year lease term depending on the building’s condition.

3.3.3.3 Determining the estimated economic life of a lease component with multiple
underlying assets

As discussed in ASC 842-10-25-5, a reporting entity should determine which asset represents the
predominant asset when a lease component contains multiple underlying assets. Only the remaining
estimated economic life of the predominant asset should be considered when classifying the lease
component.

Example 13 in ASC 842-10-55-146 through 55-149 illustrates the application of this guidance to a lease
of a turbine plant. The leased turbine plant consists of the turbine, the building that houses the
turbine, and the land under the building. The example concludes that these assets collectively
represent a single lease component. Considering the lessee entered into the lease to obtain the power-
generation capabilities of the turbine, and the land and building would have little to no use or value to
the lessee without the turbine, the turbine represents the predominant asset in the lease component.
Accordingly, the remaining economic life of the turbine should be used when evaluating the
classification of the lease component.

3.3.4 Present value of the lease payments amounts to substantially all of the fair value of the
underlying asset

This criterion (commonly referred to as the “lease payments criterion”) is met if the present value of
the sum of lease payments and any residual value guaranteed by the lessee that has not already been
included in lease payments in accordance with ASC 842-10-30-5(f) equals or exceeds substantially all
of the fair value of the underlying asset. Although the FASB did not include bright lines in ASC 842, it
has indicated that one approach to applying this indicator is to consider payments equal to or greater
than 90% of the underlying asset’s fair value.

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