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Leveraged leases

transaction to qualify as a leveraged lease and does not define how much debt would provide
“substantial leverage.” Historically, “long-term” was interpreted as nonrecourse financing being
present for a majority of the lease term.

When a lessor changes any aspect of the nonrecourse debt payment pattern, it should evaluate
whether the repayment causes the lease to fail the requirement to have a long-term creditor necessary
to continue to classify the lease as a leveraged lease.

7.3.1.2 Requirement for substantial leverage

When a lessor repays all or a portion of the nonrecourse debt, it should also consider whether the
arrangement, as altered, provides the lessor with substantial leverage. As discussed above, most
leveraged leases were originally structured to provide as much as 80% leverage in the transaction.
However, historically, a lease that was initially financed with more than 50% debt at lease
commencement was generally accepted to have had enough leverage to have qualified for leveraged
lease accounting, provided that the debt outstanding remained significant throughout the duration of
the nonrecourse debt. When nonrecourse debt amortizes ratably over its term, this requirement is
typically met.

As noted above, whenever a lessor changes any aspect of the nonrecourse debt payment pattern, it
should evaluate its specific facts and circumstances to determine whether this requirement continues
to be met such that the arrangement continues to qualify for leveraged lease accounting.

7.3.1.3 Requirement for nonrecourse debt

To be considered nonrecourse debt, the lender may only have recourse to the following interests in the
lease:

□ Unremitted rents

□ Variable rents not included in the lease receivable (i.e., contingent rents)

□ The underlying asset

□ A residual value guarantee from the lessee

If the lessor refinances the nonrecourse debt with debt that has other recourse features, the
refinancing would disqualify the lessor from applying leveraged lease accounting. In general, the
financing may not have features under which non-rental amounts due to the lessor are subordinate to
the financing. Examples of such non-rental amounts include amounts remitted to the lessor to pay for
executory costs (e.g., property insurance) or for services the lessor provides to the lessee.

7.3.2 Modifications to a leveraged lease

A lessor and lessee may negotiate changes to a leveraged lease. For example, the lessor may reduce or
restructure the rents or enter into a new arrangement to lease the asset to a new lessee. The guidance
in ASC 842-10-65-1(z), however, does not allow a lease to be accounted for as a leveraged lease if the
terms of the lease are modified on or after the effective date of ASC 842. The lessor should classify any
such lease as a new lease as of the modification date, and classify the lease as either an operating,

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