Question

1. ASC guidance provides a rule of thumb for determining whether the lease term spans a major part of the remaining economic life of the asset. What is that rule of thumb?

2. ASC guidance provides a rule of thumb for determining whether the sum of the present value of lease payments and present value of Lessee guaranteed residual value equals or exceeds substantially all of the fair value of the asset. What is that rule of thumb?

SITE ASC FOR BOTH

Answer 1

1. ASC guidance provides a rule of thumb for determining whether the lease term spans a major part of the remaining economic life of the asset. What is that rule of thumb?

This is the third criterion (test) ,(out of a toatl of 4)--in the process of deciding whether the lease is to be classified & accounted as a capital/finance lease or an operating lease, by the lessee.

Apart from other 3,The ASC 842 vide Paragraph 2 ,10-25 states that in the event of the term of the lease is for major part of the remaining economic(ie. useful) life of the leased asset, the lease is to be treated as a capital/finance lease , by the LESSEE--ie. he will take the asset in his books, claim depreciation benefits during all the years of its use.

Here, the rule of thumb,ie. Normal practice prevalent is that

if the commencement date of the lease happens to be at or near the end of the economic life of the to-be-leased asset, this criterion is not to be used for purposes of classifying the lease.

Lease term--ie. Period of the lease within which a lessee has the right to use the leased asset--- assumes significance when the inception date & actual date when the asset is made available for lessee's use by the lessor ,differs---as inputs like interest rates & fair value of the respective asset, may vary ,for calculation of lease amounts & subsequent annuities.

2. ASC guidance provides a rule of thumb for determining whether the sum of( 1.) the present value of lease payments and (2.)present value of Lessee guaranteed residual value equals or exceeds substantially all of the fair value of the asset. What is that rule of thumb?

Here, the rule of thumb,naturally ,is only --all the amounts probable of being owed by the lessee, meaning :

the second part, ie. Residual value guaranteed , is not included in the first part,for calculation purposes.

Secondly, residual value must include only those amounts that are likely,probable & predictable ,that can be recovered from the lessee-ie. There sholud be certainty about that amount ,for it to be included for comparison with the fair value of the asset.