The formulas
- PV = payment x annuity factor (x (1 + r) if paid in advance) + guarantee / (1 + r)^n
- Finance lease if any one of criteria (a) to (e) is met
- Policy applied for (c) and (d), per the approach in ASC 842-10-55-2: term >= 75% of remaining life is a major part; PV >= 90% of fair value is substantially all; criterion (c) is skipped when commencement falls in the last 25% of total life
How it works
A lessee classifies a lease as a finance lease when any of the five criteria in ASC 842-10-25-2 is met at commencement; otherwise it is an operating lease. ASC 842 sets no percentage thresholds: criteria (c) and (d) ask whether the term is a major part of the remaining economic life and whether the present value is substantially all of the fair value.
ASC 842-10-55-2 describes 75 percent of remaining economic life, 90 percent of fair value and the last 25 percent of total economic life as one reasonable approach to those judgments. It is a common practical accounting policy, and this tool applies it. A lease just under a line still calls for judgment on the criterion itself.
Illustrative figures only. Check the result against your firm's methodology before relying on it.
Common questions
Which discount rate goes in?
The rate implicit in the lease if readily determinable, otherwise the lessee's incremental borrowing rate. Private companies may elect a risk-free rate by class of asset.
Does the guarantee always go in the PV test?
Only the residual value guaranteed by the lessee that is not already reflected in the lease payments, as stated in criterion (d).
Are the 75 and 90 percent lines required?
No. They are not bright lines in ASC 842, for public or private companies. ASC 842-10-55-2 presents them as one reasonable approach, and an entity that uses them, or another approach, documents the choice as an accounting policy.
Sources
Runs in your browser. The figures you type are not sent to CORAA or stored. Check the result against your firm's methodology before relying on it.