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Leveraged leases

7.1 Chapter overview

Leveraged leases are those leases that meet the criteria in ASC 840-10-25-43(c). The guidance on
leveraged leases has not been carried forward into the leasing standard. Instead, ASC 842-10-65-1(z)
grandfathers the accounting for leveraged leases existing at its effective date. Accordingly, a lessor
should continue to apply the guidance in ASC 840 to leveraged leases that commenced prior to the
effective date of ASC 842. See LG 10 for information on effective date and transition.

ASC 840 and ARM 4650.54 provide guidance for grandfathered leveraged leases. This chapter
supplements the guidance in ARM 4650.54 and discusses how to account for changes in leveraged
lease arrangements that occur after a lessor adopts ASC 842.

Because ASC 842 does not allow a new lease to be accounted for as a leveraged lease, any new lease
should be accounted for as either operating, sales-type, or direct financing leases, as required under
ASC 842.

7.2 Definition and characteristics of a leveraged lease

Prior to the adoption of ASC 842, a lease was considered a leveraged lease if the terms of the
arrangement met specified criteria. It had to qualify as a direct financing lease under ASC 840-10-25-
43(b), and meet the criteria specific for leveraged leases in ASC 840-10-25-43(c).

Leveraged lease classification applies only to lessors. Lessees should account for leveraged leases in
the same manner as nonleveraged leases and classify them as operating or finance leases, as
appropriate. The grandfathering of leveraged leases, therefore, does not affect lessees; they should
apply the applicable transition guidance to their leases upon adopting ASC 842.

7.2.1 Classification criteria for leveraged leases

Leveraged leases have the following characteristics:

□ The terms of the lease meet the criteria to be classified as a direct financing lease, as defined in
ASC 840

□ The lease involves at least three parties: a lessee, a long-term creditor, and a lessor

□ The financing provided by the long-term creditor is nonrecourse to the general credit of the lessor
and must provide the lessor (the equity investor) substantial leverage in the transaction

□ The lessor’s net investment in the leveraged lease declines during the early years of the lease term
and subsequently rises

See ARM 4650.54 for additional guidance on the classification criteria for leveraged leases.

7.2.2 Economic rationale for leveraged leases

Historically, leveraged leases were attractive to lessees that were unable to take advantage of the tax
benefits typically associated with owning property, such as accelerated depreciation and investment
tax credits. Lessors would typically obtain nonrecourse financing for 65% to 80% of the cost of the

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