Leases: Lessors - Classification (Portfolio 5128)

BNA Tax and Accounting Portfolio 5128-2nd, Leases: Lessors—Classification (Accounting Policy and Practice Series) explains and analyzes the accounting classification of leases from the lessor's perspective.

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BNA Tax and Accounting Portfolio 5128-2nd, Leases: Lessors—Classification (Accounting Policy and Practice Series) explains and analyzes the accounting classification of leases from the lessor's perspective. The Portfolio discusses in detail the classification tests found in Topic 840 of the FASB Codification.
The Portfolio analyzes the definitions of terms relevant to classification, with specific emphasis on the calculation of minimum lease payments. The fifth in a subseries of Portfolios on accounting for leases, this work augments APP 5114, Accounting for Leases: Fundamental Principles; APP 5120-2nd, Leases: Lessor Perspective - Economics; and APP 5129, Leases: Lessor Perspective - Recording the Lease.
The FASB and the International Accounting Standards Board (IASB) are collaborating to revise and converge their standards on Accounting for Leases. This Portfolio will be updated as necessary to reflect any new rules or principles. For a summary of the most recently proposed rules and their potential impact on lessor accounting, see APP 5114, Accounting for Leases: Fundamental Principles at Section I.D.
This Portfolio may be cited as BNA Tax and Accounting Portfolio 5128-2nd, Sebik and Starczewski, Leases: Lessors—Classification (Accounting Policy and Practice Series).


Joseph P. Sebik, C.P.A.

Joseph P. Sebik, B.A., Accounting, Queens College of the City University of New York (1977); graduate credits towards MBA, Controllership, St. Johns University; Certified Public Accountant, New York State (1980); member of the Accounting Committee of the Equipment Leasing Association (ELA) since 2000; member AICPA. Mr. Sebik is a recurring speaker at ELA Accounting Conferences and has authored numerous articles on leasing. He has over 20 years of lease accounting and financial reporting experience with Price Waterhouse, IBM Credit Corporation, Citicorp Global Equipment Finance, and JPMorgan Capital. Mr. Sebik has co-authored several Accounting Policy and Practice Portfolios, including BNA Tax and Accounting Portfolio 5114, Accounting for Leases: Fundamental Principles; 5117, Leases: Lessee Perspective; 5118, Leases: Lessee Perspective—Selected Topics; and 5120, Leases: Lessor Perspective—Economics.

Lisa Marie Starczewski, Esq.

Lisa Marie Starczewski, J.D. (summa cum laude), Villanova University School of Law; B.A. (magna cum laude), Smith College. Ms. Starczewski served as Editor-in-Chief of the Villanova Law Review (1987–88) and is a member of adjunct faculty at Villanova University School of Law. She practiced law with Morgan, Lewis & Bockius, and Schnader, Harrison, Segal & Lewis. Ms. Starczewski has co-authored a number of Accounting Policy and Practice Portfolios, including BNA Tax and Accounting Portfolio 5100, Revenue Recognition: Fundamental Principles; 5101, Revenue Recognition: Product Sales and Services; 5114, Accounting for Leases: Fundamental Principles; 5117, Leases: Lessee Perspective; 5118, Leases: Lessee Perspective—Selected Topics; and 5120, Leases: Lessor Perspective—Economics. She has also authored numerous Tax Management Portfolios (also published by BNA), including 714 T.M., Partnerships—Allocation of Liabilities; Basis Rules; 565 T.M., Installment Sales; 752 T.M., Corporate Alternative Minimum Tax; 587 T.M., Noncorporate Alternative Minimum Tax; 503 T.M., Deductions: Overview and Conceptual Aspects; and 504 T.M., Deduction Limitations: General. She has received the Tax Management Distinguished Author Award and is a member of the Tax Management U.S. Income Advisory Board.

Table of Contents

Detailed Analysis

I. Lease Classification-Lessors

A. Introduction and Scope of Portfolio

B. Derivation of Lease Classification Guidelines

C. General Classification Guidelines-Equipment (Assets Other Than Real Estate)

D. Equipment Assets-Detailed Classification Analysis

1. Collectibility of Lease Receivables and Certainty of Unreimbursable Costs (FAS 13, ¶ 8)

a. The General Tests

b. Interpretation of "Reasonably Predictable"

(i) Allowance for Bad Debts

(ii) Lessee in Bankruptcy

(iii) Credit Ratings of Lessees' Debt

c. Uncertainties Regarding Unreimbursable Costs

2. Classification Tests (FAS 13, ¶ 7)

a. Automatic Title Transfer Test-¶ 7(a)

b. Bargain Purchase Option Tests-¶ 7(b)

c. Lease Term Test-¶ 7(c)

d. 90% Present Value Test-¶ 7(d)

(i) In General

(ii) Components of 90% Present Value Test

(iii) Application of the 90% Present Value Test When Lessee Options Exist

3. Sales-Type Lease Classification for Equipment (FAS 13, ¶ 6)

4. Leveraged Lease Classification Criteria (FAS 13, ¶ 42)

II. Inception of a Lease

Introductory Material

A. General Definition

B. Inception of the Lease in Contrast to Asset Recording Date

C. Inception Date in Build-to-Suit Lease Transactions

D. Inception Date Under a Master Lease Agreement

1. Background

2. Determination of Inception Date Under an MLA

3. Master Leases Used to Aggregate Assets Under a Single Lease

III. Minimum Lease Payments

Introductory Material

A. General Definition of Minimum Lease Payments

B. Lowest-Cost Concept

C. Contingent Rentals

1. Interim Rents

a. In General

b. Treatment of Interim Rents Under Certain Master Lease Agreements

2. Excess Wear and Tear

3. Treatment of Changes in Indexed Underlying Borrowing Costs

4. Charges Resulting From Excess Usage Above a Baseline Allowable Usage

5. Contingent Rents Based on a Certain Event

6. Rents Based Solely on Usage

D. Treatment of Loans That Are Non-Recourse to Both Lessee and Lessor

E. Lessee Guarantee of Lessor's Debt

F. Lessee Loans to Special Purpose Entities Holding a Lease

G. Lessee Executory Costs

H. Residual Value Guarantees

I. Lease Renewal Guarantees

J. Lease Termination Fees

K. Imputed Interest Income From Security Deposits

L. Lessor Transaction and Administrative Fees Paid by Lessee

M. Payments Received Prior to the Commencement of the Lease

N. Imputed Value of a Purchase Option Transferred to Lessor

O. Excessive Asset Return and Remarketing Costs to Be Paid by or Incurred by the Lessee

P. Lessor's Right to Utilize Property Without Payment of Adequate Consideration

Q. Lessee Commitment to Arrange Subsequent Financing or Acquire Leased Asset If Lease Debt Is Not Refinanced

R. Investments Made or Committed to Be Made by Lessee in the Lessor at or Near the Inception of the Lease

S. Lessee Loans to the Lessor That Remain Outstanding at the Expiration of the Lease

T. Treatment of Executory Costs Associated With a Lease

U. Make-Whole Premiums on Non-Renewals or Early Terminations

V. Payments to Be Made Under Non-Performance-Related Default Covenants

W. Lessee Indemnification of Pre-existing Environmental Contaminations

X. Lessee Requirement to Fund Upgrades or Improvements to Assets

Y. Asset Retirement Obligations Under FAS 143

IV. Definitional Issues That May Impact Classification

Introductory Material

A. Related Parties

1. General Definition

2. Classifying Leases Between Related Parties

3. Related Parties in Leveraged Lease Transactions

B. Fair Value of the Leased Property

1. Basic Definition

2. Ensuring Related Parties Acquire Assets at Fair Value

3. Determining Fair Value for Certain Sale-Leasebacks of Equipment

4. Effect of Miscellaneous Costs on Fair Value

5. Effect of Lessor's Volume or Trade Discounts on Fair Value

6. Fair Value Greater Than Contracted Cost

7. Determining Fair Value on Existing Assets Already Under Lease

8. Effect of Asset Retirement Obligations on Minimum Lease Payment and Fair Values

C. Bargain Purchase Option

D. Bargain Renewal Option

E. Lease Term

1. Noncancelable Nature of a Lease

a. Remote Contingency

b. Permission to Cancel

c. New Lease

d. Penalty for Cancellation

2. Periods Included in the Term of a Lease

a. Bargain Renewal Option

b. Penalty Imposed for Failure to Renew

c. Lessee Expected to Guarantee the Debt

d. Purchase Option

F. Estimated Economic Life of Leased Property

G. Estimated Residual Value of Leased Property

1. General Definition

2. Retail Fair Market Residual Value

3. Wholesale Fair Market Residual Value

4. Orderly Liquidation Residual Value

5. Distressed Value

6. Selecting a Residual Value Method

H. Unguaranteed Residual Value

1. General Definition

2. TRAC Lease Residual Value Guarantees

3. Lessee Residual Value Guarantees in Synthetic Leases

I. Interest Rate Implicit in the Lease

1. General Definition

2. Effect of Tax Leases on Implicit Interest Rates

3. Effect of Investment Tax Credit on Implicit Interest Rate

J. Determining Lessee's Incremental Borrowing Rate

K. Initial Direct Costs

1. Background

2. Definition-FAS 91

3. Fees Received by Lessor

a. Initial Direct Costs

b. Commitment Fees

c. Syndication Fees

d. Underwriting Fees

4. Exclusion of Loss Allowance From Initial Direct Costs

5. Initial Direct Costs Associated With Acquiring a Portfolio of Leases

L. Penalties

Working Papers

Working Papers


Worksheet 1 Glossary

Worksheet 2 Lease Classification Flowchart

Worksheet 3 Comparison of Projected Value and Lease Balance



Internal Revenue Service

Financial Accounting Standards Board

FASB Statements

FASB Interpretations

FASB Emerging Issues Task Force (EITF) Consensus Positions

APB Opinions

American Institute of Certified Public Accountants

AICPA Auditing Standards

AICPA Issues Papers



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