The Details Behind FASB

Determining the Lease Term

The calculation of Liability & Asset amounts starts on:

  • The lease commencement date of a new lease
  • On the date that a renewal option is executed (not the renewal date)

The lease term will include renewal options that are “reasonably certain” to be exercised:

  • But “reasonably certain” is considered a high threshold to meet
  • Companies will develop their own criteria to gauge what option they consider reasonably certain to exercise

Leases of 12 months or less are excluded from the requirements of the new standards.

The Lease Liability Calculation

Lease Liability is calculated taking the present value of outstanding lease payments

  • The discount rate used is either the implicit interest rate in the lease or the lessee’s incremental borrowing rate
  • Excludes operating (or non-lease) expenses and variable lease payments
  • Operating expenses can be estimated but if splitting payments is too complex, then gross payments can be used
  • Fixed property tax and insurance payments in gross rent paid by the landlord will be included
  • For fixed index changes, the current index value will be used throughout the lease

Measurement of the Right-of-Use Asset

"Right-of-Use" is calculated starting with the capitalized lease liability and adjusted for initial direct costs such as:

  • Allowances
  • Prepayments before commencement date
  • Incentive payments
  • Costs associated with securing the lease/property
  • Impairments

Classifying the Lease

A lease is a finance lease if one of the following is true:

  • You have the right to acquire all or part of the underlying asset after the lease expires
  • You have a purchase option that you’re reasonably certain to exercise
  • The lease liability is greater than 90% of the Asset Fair Value at inception
  • The lease term lasts longer than 75% of the Remaining Economic Life of the asset
  • The asset’s specialized nature would prohibit alternative use to you at the lease expiration

If none of these apply, then the lease is considered an operating lease.