BAR, Business Analysis and Reporting
Sources for Leases: Classification, Modifications, and Sale-and-Leaseback
Last reviewed
The standards and authorities behind PocketCPA's BAR lessons on Leases: Classification, Modifications, and Sale-and-Leaseback. The topic rests on ASC 842.
About this topic
A lessee that calls a contract a finance lease and a lessee that calls the identical contract an operating lease post the same commencement entry, to the penny. They also charge the same total to income across the term. Classification decides when the cost lands and what the line is called, and it decides nothing else. That is the shape of the whole Topic. Every question in it is a sorting question, and the answer moves large amounts between periods, between captions and occasionally between balance sheets. The fact that settles it usually arrives in a single clause.
ASC 842 is a set of sorting rules rather than a measurement standard, and BAR tests it accordingly. A fact pattern arrives carrying two or three percentages, and the question is which side of a line they land on, so what is graded is calibration rather than recitation. The error that costs most sits on the lessor's side and turns on a single word in the facts. Criterion (d), the substantially-all test that can make a lease sales-type, counts only a residual guaranteed by the lessee. The substantially-all test that can make the same lease direct financing counts a residual guaranteed by the lessee or by an unrelated third party. The same dollars of guarantee therefore land in different buckets depending on who wrote the guarantee, and most BAR lessor items turn on that fact alone.
Key points
- Lease classification uses five tests; meeting any one makes it a finance lease for the lessee.
- Modifications that change the scope and price proportionately are treated as a separate lease.
- A sale-and-leaseback is recognized only if the transfer qualifies as a sale under ASC 606 control criteria.
- The lessee remeasures the lease liability at a modification-date discount rate.
What the lessons cover
- Lessee classification: finance versus operating
- Lessor classification: sales-type, direct financing, operating
- Modifications
- Sale-and-leaseback
- Lessor modifications: what happens to the net investment
- Collectibility that is not probable: the lessor's deposit-liability path
Authoritative references
Where these requirements sit in the literature.
- ASC 842-10-25-1 fixes the timing: classify each separate lease component at the commencement date, and do not reassess unless the contract is modified and the modification is not a separate contract under 842-10-25-8.
- ASC 842-10-25-2 holds the five lessee classification criteria, and via the Master Glossary it is also where sales-type classification comes from for a lessor.
- ASC 842-10-25-3(b) holds the two direct financing conditions:
- The substantially-all test, which counts a residual guaranteed by the lessee or an unrelated third party.
- Probable collection.
- ASC 842-10-25-4 requires a lessor to run 25-2(d) and 25-3(b)(1) at the rate implicit in the lease.
- ASC 842-10-25-3A is the ASU 2021-05 override sending a lease with non-index variable payments to operating when sales-type or direct financing would produce a day-one selling loss. Its reach is confirmed by the amended Master Glossary, where both the Sales-Type Lease and Direct Financing Lease definitions now end with "and is not an operating lease in accordance with paragraph 842-10-25-3A".
- ASC 842-10-25-8 is the modification gate, and 842-10-25-9 through 25-14 is the lessee chain that follows a failed gate.
- ASC 842-10-25-15 through 25-17 is the lessor chain, sorted by the lease's original classification.
- 842-10-25-18 points to Examples 15 through 22 at 842-10-55-159 through 55-209 for the illustrations.
- ASC 842-30-25-1 is sales-type recognition.
- 842-30-25-7 and 25-8 are direct financing recognition and the deferral of selling profit and initial direct costs.
- 842-30-25-10 through 25-13 are lessor operating recognition and the collectibility ceiling on operating lease income.
- ASC 842-30-25-3 through 25-6 is the collectibility-not-probable path, and it carries four consequences:
- No derecognition.
- No net investment.
- A deposit liability.
- No reassessment of collectibility once it is probable.
- ASC 842-40 is sale-and-leaseback in its entirety, and its paragraphs run in this order:
- 842-40-15-2 binds both parties to it.
- 842-40-25-1 through 25-3 are the three sale gates.
- 842-40-25-4 and 25-5 are the consequences of passing and failing.
- 842-40-30-1 through 30-4 are the off-market rules and the related-party exception.
- 842-40-30-6 is the rate adjustment on a failed sale's financial liability.
- The worked illustrations sit at 842-40-55-22 through 55-38.
How PocketCPA uses these sources
Every lesson is written in original words and cites the paragraph each rule comes from. No standard's text is reproduced. How lessons and questions are written and checked is set out in our methodology.