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Modification and remeasurement of a lease

Operating lease The lessor should recognize the underlying asset at Example 5-12
the carrying amount of the net investment in the
original lease immediately before the effective date of
the modification. Initial direct costs incurred in
conjunction with the modification are initially
capitalized and then recognized as an expense on the
same basis as lease income.

Example 5-10, Example 5-11 and Example 5-12 illustrate the accounting for the modification of a direct
financing lease.

EXAMPLE 5-10

Modification of a direct financing lease that does not impact classification

On January 1, 20X1, Lessee Corp enters into a contract with Lessor Corp to lease non-specialized
digital imaging equipment.

The following table summarizes information about the lease and the leased assets at lease inception.

Lease term 5 years, no renewal option

Economic life of the leased equipment 10 years

Purchase option None

Annual lease payments $195,000

Payment date Annually on January 1

Fair value of the leased equipment $1,200,000

Lessor Corp’s carrying value of the leased equipment $1,200,000

Estimated residual value $400,000

Residual value guarantee $300,000 residual value guarantee is
provided by a third party unrelated to
Lessee Corp or Lessor Corp

Interest rate charged in the lease 5.0%

Other Title to the asset remains with Lessor
Corp upon lease expiration

At lease commencement, Lessor Corp concludes that the lease is not a sales-type lease because none of
the criteria in ASC 842-10-25-2 are met. Lessor Corp concludes that the lease is a direct financing
lease because the sum of the present value of the lease payments and the present value of the residual
asset guaranteed by the third-party guarantor is substantially all of the fair value of the leased
equipment and collectibility of the lease payments is probable. Therefore, Lessor Corp initially

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