- Lease liability is recorded as the present value of the unpaid lease payments, discounted at a rate implicit in the leases (if known), or at the lessee’s incremental borrowing rate. Lease payments include:
- Fixed payments, and in-substance fixed payments (i.e., variable payment that includes a floor/minimum amount)
- Variable payments if based on an index or rate (variable payments excluded if based on usage or asset performance)
- Amount that is probable will be owed under residual value guarantee
- Payments related to renewal or termination options that the lessee is reasonably certain to exercise
- The Right of Use Asset is recorded as the lease liability, plus initial direct costs, plus prepaid lease payments, less lease incentives received.
- The handling of former Executory Costs is as follows:
- If they are added to the lease cost based on the lessor’s actual costs, they are variable costs and are expensed as incurred.
- If they are fixed and included in the least cost (even if stated separately), the total is considered to be part of the lease payment and is included in measurement of Right of Use Asset.
- Common Area Maintenance or other maintenance services transfer a service to the lessee other than the right to use the underlying asset are therefore a “non-lease” component of the contract. Therefore, consideration in the lease is allocated to such items and they are excluded from lease payments by lessees that elect to separately account for lease and non-lease components (i.e., these costs would be expenses as incurred). However, lessees can make an accounting election to include non-lease components as part of lease payments (i.e., costs considered to be part of the lease payment and are included in measurement of the Right of Use Asset).
- With a lease classified as a finance lease, both interest and amortization expenses are to be charged to the income statement (the same as the former treatment of a Capital Lease); a lease is classified as a finance lease if it meets ANY of the following five criteria:
- Lease transfers ownership of the asset to the lessee by the end of the lease term.
- Lease grants the lessee an option to purchase the asset that the lessee is “reasonably certain” to exercise.
- Lease term is for the major part (e.g., 75%) of the remaining economic life of the asset.
- Present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all (e.g., 90%) of the fair value of the asset.
- The asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
- With a lease classified as an operating lease, the lease expense is to be charged to the income statement (the same as the former treatment of an Operating Lease); a lease is classified as an operating lease if it meets NONE of the above listed criteria.
- Whether any expired or existing contracts are leases or contain leases
- The lease classification for any expired or existing leases
- Initial direct costs for any existing leases