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Leveraged leases

sales-type, or direct financing lease based on the guidance in ASC 842. See LG 3 for information on
lease classification.

As noted in LG 7.2, leveraged lease classification applies only to lessors. Accordingly, whenever a
leveraged lease is modified, notwithstanding that the lessor should account for the modified
agreement as a new lease, the lessee may not have to do so. Rather, the lessee should account for the
modification in accordance with the guidance in ASC 842-10-25-8. See LG 5 for information on lease
modifications.

7.3.2.1 Replacing the lessee

When the original lease agreement is replaced by a new agreement with a different lessee, the original
leveraged lease is considered terminated. As discussed in LG 7.3, since ASC 842 does not permit new
leveraged leases, the lessor should classify the new lease as operating, sales-type, or direct financing
based on the guidance in ASC 842. See LG 3 for information on lease classification.

7.3.2.2 Discontinuing the use of leveraged lease accounting

As previously noted, changes to a leveraged lease may require a lessor to account for the lease as a new
lease. To apply the guidance in ASC 842, the lessor should separately account for each of the
components of its net investment that had been subject to leveraged lease accounting in accordance
with the applicable GAAP for that component. Accordingly, the lessor should separately report the
property subject to the new lease and the nonrecourse debt (i.e., the lessor will gross-up its balance
sheet). While ASC 840-30-40-7 contains specific guidance on how a lessor should measure the leased
property upon termination of a lease, that guidance was superseded by ASC 842. See LG 6.5.2.1 for
guidance on how the lessor should measure the leased property upon termination of a lease.

Due to the unique income recognition pattern for leveraged leases, deferred taxes included in the net
investment in the leveraged lease are accounted for in a manner prescribed by ASC 842-50-35-4.
When a lessor discontinues use of leveraged lease accounting, it should also adjust any associated
deferred tax assets or liabilities to reflect the amount it would have recognized had it accounted for
those deferred taxes in accordance with ASC 740. The adjustment should be recognized in income tax
expense in the period in which leveraged lease accounting is discontinued.

7.3.3 Changes in the underlying assumptions

ASC 842-50-35-6 requires a lessor to review the estimated residual value and all other important
assumptions used to determine the estimated total net income from the leveraged lease on at least an
annual basis. The projected timing of income tax cash flows generated by the lease is an important
assumption that should also be reviewed annually, or more frequently if events or circumstances
indicate a change in the timing has occurred or might occur.

Changes in important assumptions require a lessor to recognize immediate gains or losses and change
its scheduled income recognition, prospectively. However, changes to assumptions alone would not
typically require a lessor to reassess lease classification. See ARM 4650.54 for further information
regarding the effects of a change in the projected timing of income tax-related cash flows.

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