How do lessors classify leases under ASC 842 and IFRS 16?

Accounting standards require lessors to identify lease transactions that transfer to the lessee control over the leased asset and substantially all of the risks and rewards incidental to the asset's ownership.  Lessors are required to identify and separately account for lease and non-lease components in the arrangements.

For identification of a finance lease, the transaction must meet any one of the following criteria:

1. The lease transfers ownership of the leased asset from the lessor to the lessee by the end of the lease term;
2. The lease grants the lessee an option to purchase the leased asset from the lessor that is reasonably certain to be exercised;
3. The lease term is for a major part of the remaining economic life of the underlying asset;
4. The present value of lease payments and any residual value guaranteed by the lessee that is not already included in the lease payments equals or exceeds substantially all of the leased asset’s fair value; or
5. The leased asset is of such a specialized nature that no alternative use to the lessor is expected at the end of the lease term.

IFRS 16 and ASC 842 use these determinative criteria to establish whether the lease term is for the “major part” of the asset’s useful life and whether its present value is “substantially equal” to the asset’s fair market value – ASC 842 eliminates the ASC 840 bright-line tests.  Under IFRS 16 these criteria can be considered individually or together in combination, while under ASC 842 each classification criterion is determinative.

Subleases and sale and leaseback transactions are classified differently under IFRS 16 and ASC 842.