Page 104 - pwc-lease-accounting-guide_Neat

Lease classification

ASC 842-30-25-3

The guidance in paragraphs 842-30-25-1 through 25-2 notwithstanding, if collectibility of the lease
payments, plus any amount necessary to satisfy a residual value guarantee provided by the lessee, is
not probable at the commencement date, the lessor shall not derecognize the underlying asset but
shall recognize lease payments received–including variable lease payments–as a deposit liability until
the earlier of either of the following:

a. Collectibility of the lease payments, plus any amount necessary to satisfy a residual value
guarantee provided by the lessee, becomes probable. If collectibility is not probable at the
commencement date, a lessor shall continue to assess collectibility to determine whether the lease
payments and any amount necessary to satisfy a residual value guarantee are probable of
collection.
b. Either of the following events occurs:

1. The contract has been terminated, and the lease payments received from the lessee are
nonrefundable.

2. The lessor has repossessed the underlying asset, it has no further obligation under the contract
to the lessee, and the lease payments received from the lessee are nonrefundable.

The term “probable” is defined in US GAAP as “likely to occur,” and is generally interpreted as a 75%
to 80% likelihood. A lessor’s assessment of probability of collection should be performed at lease
commencement and reflect both the lessee’s ability and intent to pay as amounts become due
considering all relevant facts and circumstances. See RR 2.6.1.5 for additional information on
assessing the probability of collection.

If a lessor concludes at lease commencement that the lease meets the criteria to be classified as a sales-
type lease, but collection of lease payments or any amount due to satisfy a residual value guarantee is
not probable, the lessor should not derecognize the asset or recognize any selling profit. Any lease
payments received should be recorded as a deposit liability until either of the criteria outlined in ASC
842-30-25-3 occurs. See 4.3.1 for guidance addressing how to account for a lease once the collectibility
criteria are met.

Direct financing leases should be classified as an operating lease if lease payments, plus any amount
necessary to satisfy a residual value guarantee, including third party guarantees, are not probable of
collection at lease commencement. The lessor cannot classify the lease as a direct financing lease
because the conversion of the lessor’s asset risk to credit risk (which occurs when a lessor effectively
transfers the risks and rewards of ownership of the underlying asset to the lessee) is nonsubstantive.

Even when a lease is classified as an operating lease, the lessor should still assess the collectibility of
payments. At lease commencement, if a lessor determines that operating lease payments are not
probable of collection, the recognition of lease income is limited to the lesser of the following:

□ Lease income that would have been recorded to date (i.e., straight-line rental income), plus
variable lease payments

□ Lease payments, including variable lease payments, received to date

3-38