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Lease classification

This criterion requires the comparison of the lease payments to the fair value of the lease component
(i.e., the underlying asset), not to the fair value of the right to use the asset subject to the lease
arrangement. This is an important distinction because most leases are for a period shorter than the
economic life of the underlying asset, therefore, the fair value of the asset and the right to use the asset
will differ. Additionally, when a lease component includes multiple underlying assets, the fair value
should be for the group, which may differ from the sum of the fair values of the individual assets.

Other factors, such as tax credits, may impact fair value. A lease arrangement may allow a lessor to
retain certain tax credits related to the underlying asset; for example, tax credits related to the
construction and ownership of the underlying asset. Tax credits are typically associated with the
ownership of, not the use of, the underlying asset. Therefore, tax credits retained by the lessor should
be excluded from the determination of fair value.

Fees paid to special-purpose entity owners should be excluded from the fair value of the underlying
asset as discussed in ASC 842-10-30-5. However, these fees should be included as lease payments.

Excerpt from ASC 842-10-30-5(e)
Fees paid by the lessee to the owners of a special-purpose entity for structuring the transaction . . .
shall not be included in the fair value of the underlying asset for purposes of applying paragraph 842-
10-25-2(d).

ASC 842-10-55-3 provides guidance regarding the classification of a lease when it is not practicable for
a reporting entity to determine the fair value of the underlying asset.

ASC 842-10-55-3

In some cases, it may not be practicable for an entity to determine the fair value of an underlying asset.
In the context of this Topic, practicable means that a reasonable estimate of fair value can be made
without undue cost or effort. It is a dynamic concept; what is practicable for one entity may not be
practicable for another, what is practicable in one period may not be practicable in another, and what
is practicable for one underlying asset (or class of underlying asset) may not be practicable for another.
In those cases in which it is not practicable for an entity to determine the fair value of an underlying
asset, lease classification should be determined without consideration of the criteria in paragraphs
842-10-25-2(d) and 842-10-25-3(b)(1).

See PwC’s Fair value measurements guide for further discussion of fair value measurements.

Question 3-13

Can a lessee recognize a right-of-use asset that exceeds the fair value of the underlying asset?

PwC response
ASC 842 does not specifically preclude a lessee from recording a right-of-use asset that exceeds the fair
value of the underlying asset. However, it would be unusual for a lessee to knowingly pay more than
fair value for an asset. Consequently, in these circumstances, a lessee should question the factors
considered in the measurement of the right-of-use asset. For example, a lessee should reconsider the

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