Question

Identify the lease classifications for lessors and the criteria that must be met for each classification

Answer 1

Answer

A lessor may classify leases for accounting purposes as follows: (1) operating leases, (2) direct-financing leases, (3) sales-type leases. The lessor should classify and account for an arrangement as a direct-financing lease or a sales-type lease if, at the date of the lease agreement, the lease meets one or more of the Group I criteria (as shown in Learning Objective 2 for lessees) and both of the following Group II criteria. Group II: (1) Collectibility of the payments required from the lessee is reasonably predictable; and (2) no important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease. The lessor classifies and accounts for all leases that fail to meet the criteria as operating leases.

The nature of each lease classification, there can be an impact on profit and debt capacity. Since operating leases are off-balance sheet, the company’s capital structure does not change due to the operating lease. In contrast, a capital lease may make a company more debt heavy, thereby impacting its debt capacity.

From the standpoint of lessors, leases that meet one or more of the following four criteria:

1.The lease transfers ownership,

2.The lease contains a bargain purchase option,

3.The lease term is equal to 75% or more of the estimated economic life of the property,

4.The present value of the minimum lease payments (excluding executory costs) equals orexceeds 90% of the fair value of the property.

And meet both of the following criteria:

1.Collectibility of the payments required from the lessee is reasonably predictable, and

2.No important uncertainties surround the amount of unreimbursable costs yet to be incurredby the lessor,

Capital leases are classified as direct-financing leases or sales-type leases. All other leases areclassified as operating leases.

The distinction for the lessor between a direct-financing lease and a sales-type lease is the presenceor absence of a manufacturer’s or dealer’s profit or loss.