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Modification and remeasurement of a lease

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.

Account for the modified lease

To account for the modified lease, Lessor Corp would carry forward the net investment in the lease
immediately before the effective date of the modification ($1,055,201); this would be the opening
balance of the net investment in the modified lease. To retain the same net investment in the lease
while the lease payments, lease term, and estimated residual value have changed, Lessor Corp must
adjust the discount rate for the lease from the rate implicit in the modified lease of 6.75% to the rate
that when applied to the total remaining lease payments and the estimated residual value produces a
present value equal to the initial net investment of $1,055,201, which is 4.66%. Prospectively, Lessor
Corp would recognize interest income on the lease based on 4.66%.

EXAMPLE 5-11

Modification of a direct financing lease that changes lease classification to a sales-type lease

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

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