Leasing – Determining the lease term

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“I m jillian pierce. A senior manager in pwc s national office. Upon adoption of of the new lisa s standard companies will bring virtually all lisa s on to balance sheet. The lease term is one of the key inputs that can impact the classification and measurement of elise identifying the lease term may not always be as simple as it seems and getting this wrong could have a significant impact on a company s accounting in this video.

I ll discuss some key considerations for determining the term of a lease and the relationship between the lease term and the short term lease. Exception. That is available for lessees to determine the lease term first start with the non cancelable period of the lease then add any renewal option periods for renewals. The lessee is reasonably certain of exercising third at any periods covered by a termination option.

If the lessee is reasonably certain it will not exercise that option fourth at any periods from an option to extend or not terminate the lease that are controlled by the lessor. The sum of these four items equals the lease term determining the lease term sounds relatively simple. But there are some nuances for example you may have noticed that the treatment of renewal and termination options depends on whether the lessee is reasonably certain to exercise the option so that begs the question..


What exactly does reasonably certain mean the good news is that the concept of reasonably certain in the new leases. Guidance is the same as reasonably assured in the current guidance. The determination of whether exercise of an option is reasonably certain is based on factors at the least commencement date. That would create an economic incentive for the lessee either to exercise or to not exercise the option examples of factors that could create economic incentives include the pricing of a lease renewal option below market rates significantly sold improvements that would be impaired.

If the term was not extended lease termination or relocation costs that would be avoided by extending the lease and the importance of the leased asset to the lessees operations in avoiding any business. Interruption. Lessees show teens. That are all factors together to determine whether exercise of an option is reasonably certain evaluating renewal and termination options requires judgment.

But it is a key step in determining the lease term. This judgment is critically important to assessing lease. Classification and measurement..


The lease term. Also determines whether a lease qualifies for the short term lease. Exception. Which could provide relief to lessees upon adoption of the new standard.

The new leases guidance provides a short term lease exception in which lessees may elect to not apply the new recognition guidance for short term leases this election should be made by class of underlying asset so for example leases of office space or leases of office equipment if the lessee chooses to elect the short term lease exception. It would not recognize a right of use asset or lease liability on its balance sheet and instead would recognize the lease payments as an expense on a straight line basis over the lease term consistent with the current leases guidance. So what exactly qualifies as a short term lease as defined in the new guidance. A short term lease is a lease that at the commencement date has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise let s highlight two points in the definition first the evaluation of whether a lease qualifies as short term is based on the contractual lease term at the commence date.

This evaluation is not based on the remaining lease term at the time. A lessee adopts. The new leases guidance..


The second point to highlight is that to qualify for this exception. The lease term must be 12 months or less. We believe that this definition should be applied strictly and should consider the impacts of renewal and termination options. Let s take an example consider a 5 year lease that commenced on january 1st.

2015. And has no purchase or renewal. Options. The lessee will adopt the new leases guidance on january 1st.

2019. At which point the remaining term is 12. Months since the original term of the lease at the commencement date was 5 years this lease would not qualify for the short term lease exception so in summary..


It s critical to understand and evaluate all provisions in each lease agreement small changes can impact if elyse qualifies as a short term lease which may affect alessi s accounting for the arrangement. The effective date of the new lease is standard is quickly approaching as companies prepare to apply the new guidance to their lease portfolios. They will be making many judgments. That will impact the classification and measurement of right of use assets and lease liabilities determining the lease term and identifying leases that qualify for the short term lease exception are just a couple of these judgments.

The good news is there are many resources available to help think through all aspects of the new leases. Guidance for more information. Please refer to the leases page on cfo direct comm. Thank you and good luck.

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