Page 177 - pwc-lease-accounting-guide_Neat

Modification and remeasurement of a lease

EXAMPLE 5-3

Remeasurement of finance lease for a change in expected purchase option exercise - no impact to lease
classification

On January 1, 20X1, Lessee Corp enters into a contract with Lessor Corp to lease manufacturing
equipment.

The lease has the following terms:

Lease commencement date January 1, 20X1

Lease term 5 years with no renewal option

Economic life of the equipment 6 years

Annual lease payments $100,000

Payment date Annually on January 1

Purchase option Lessee Corp can purchase the equipment from
Lessor Corp at the end of the lease term for
$30,000; this is not considered a bargain
purchase option

Lessee Corp determines that the lease is a finance lease. Lessee Corp’s incremental borrowing rate at
the lease inception date is 5%.

At the lease commencement date, it was not reasonably certain that the Lessee Corp would exercise
the purchase option because the lease for the manufacturing facility (where the leased equipment is
used) was ending in five years. Since Lessee Corp was not certain if it would continue to occupy its
current manufacturing location after five years, there was a reasonable possibility that the equipment
under lease would no longer be used after that time because the equipment was designed specifically
for the current facility.

On January 1, 20X3, Lessee Corp negotiated a contractual modification to the manufacturing facility
lease to extend that lease for another ten years. As a result of that modification, Lessee Corp is now
reasonably certain that it will exercise the purchase option in the equipment lease (in three years).
Making the contractual modification to the manufacturing facility lease was a signficant event
controlled by Lessee Corp, which is now reasonably certain that it will exercise its purchase option in
the equipment lease. Lessee Corp is thereforerequired to reassess and remeasure the equipment lease
on January 1, 20X3 (the beginning of year 3 of the lease).

Lessee Corp reassesses the lease classification and determines that it is still a finance lease.

5-15