Chapter 21 - WP Notes

What is the rule to be classified as a finance lease?

It must be non-cancelable and meet at least one of the 5 tests.

Under an operating lease, how does the lessee amortize the right of use asset?

Thee lessee amortizes the right-of-use asset such that the total reported lease expense is the same from period to period. In other words, for operating leases, only a single lease expense (comprised of interest on the liability and amortization of the right-of-use asset) is recognized on the income statement, typically on a straight-line basis.

What is a short term lease?

A short-term lease is a lease that, at the commencement date, has a lease term of 12 months or less. Rather than recording a right-of-use asset and lease liability, lessees may elect to expense the lease payments as incurred. [18] Leases may include options to either extend the term of the lease (a renewal option) or to terminate the lease prior to the contractually defined lease expiration date (a termination option). In these situations, renewal or termination options that are reasonably certain of exercise by the lessee are included in the lease term. Therefore, a one-year lease with a renewal option that the lessee is reasonably certain to exercise is not a short-term lease. Illustration 21.33 provides an example of two short-term lease situations

How does the lessee report right of use assets and related lease liabilities?

At December 31, 2020, lessee reports right-of-use assets and related lease liabilities separately from other assets and liabilities on its balance sheet, or discloses these assets and liabilities in the notes to its financial statements. Lessee classifies the portion of the liability due within one year or the operating cycle, whichever is longer, with current liabilities, and the rest with noncurrent liabilities

What are the qualitative disclosures to be provided by both lessees and lessors?

- Nature of its leases, including general description of those leases. - How variable lease payments are determined. - Existence and terms and conditions for options to extend or terminate the lease and for residual value guarantees. - Information about significant assumptions and judgments (e.g., discount rates).

What are the 3 other lease adjustments?

1) Executory costs 2) Lease prepayments and incentives 3) Initial direct costs

What are the 5 unique accounting problems as a result of lease arrangements?

1) Residual values 2) Other lease adjustments 3) Bargain purchase options 4) Short term leases 5) Presentation, disclosure, and analysis

What are lease prepayments and incentives?

Companies adjust the right-of-use asset for any lease prepayments, lease incentives, and initial direct costs made prior to or at the commencement date. These adjustments determine the amount to report as the right-of-use asset at the lease commencement date as follows. 1. Lease prepayments made by the lessee increase the right-of-use asset. 2. Lease incentive payments made by the lessor to the lessee reduce the right-of-use asset. 3. Initial direct costs incurred by the lessee (discussed in the next section) increase the right-of-use asset. Initial measurement of lease liability + prepaid lease payments - lease incentives received + initial direct costs = right of use asset

What does the accounting for a lease arrangement by lessees and lessor depend on?

Depends on the classification of the lease as a sale of the underlying asset. If the lease is in substance a sale, the lease is classified as a finance lease.

What does classification of the lease as either a sales-type lease or operating lease determine?

Determines the accounting by the lessor. For a sales-type lease, the lessor accounts for the lease in a manner similar to the sale of an asset. Under a sales-type lease, the lessor generally records a Lease Receivable and eliminates the leased asset. The lease receivable for Sterling is computed as shown in Illustration 21.11.

How does a lessee report information related to finance and operating leases in the financial statements?

Finance lease: 1) Balance sheet = right of use asset and lease liability 2) Income statement = amortization and interest expense Operating lease: 1) Balance sheet = right of use asset and lease liability 2) Income statement = lease expense

What is the lessor perspective on a guaranteed residual value?

In computing the amount to be recovered from the rental payments, the present value of the residual value was subtracted from the fair value of the backhoe to arrive at the amount to be recovered by the lessor.

How is a lease receivable computed?

Present value of rental payments + Present value of guaranteed and unguaranteed residual values. Any selling profit on the transfer of the leased asset is recognized by recording sales revenue and related cost of goods sold at the commencement of the lease. The lessor recognizes interest revenue on the lease receivable over the life of the lease using the effective-interest method.

Under an operating lease, how does the lessee report information on the income statement each year?

Presents the interest and right-of-use asset amortization related to the lease as a single lease (operating) expense in the income statement each year.

Under a finance lease, how does the lessee record amortization expense?

Records amortization expense on the RIGHT OF USE ASSET generally on a straight line basis

Under an operating lease, how does the lessee measure interest expense?

The lessee measures interest expense using the effective interest method, which is the same as under a finance lease.

Under a finance lease, how does the lessee recognize interest expense?

The lessee recognizes interest expense on the lease liability over the LIFE of the lease using the effective interest method.

What is the type of quantitative information that should be disclosed for the lessee?

Total lease cost. Finance lease cost, segregated between the amortization of the right-of-use assets and interest on the lease liabilities. Operating and short-term lease cost. Weighted-average remaining lease term and weighted-average discount rate (segregated between finance and operating leases). Maturity analysis of finance and operating lease liabilities, on an annual basis for a minimum of each of the next five years, the sum of the undiscounted cash flows for all years thereafter.

What type of measurement does an operating lease follow for expenses?

Unlike a finance lease, the lessee records the same amount for lease expense each period over the lease term (often referred to as the straight-line method for expense measurement). Companies continue to use the effective-interest method for amortizing the lease liability. However, instead of reporting interest expense, a lessee reports interest on the lease liability as part of Lease Expense. In addition, the lessee no longer reports amortization expense related to the right-of-use asset. Instead, it "plugs" in an amount that increases the Lease Expense account so that it is the same amount from period to period. This plugged amount then reduces the right-of-use asset, such that both the right-of-use asset and the lease liability are amortized to zero at the end of the lease

What are 4 advantages of leasing from the perspective of the lessee?

1) 100% financing at fixed rates. 2) Protection against obsolescence 3) Flexibility 4) Less costly financing 1 - Leases are often signed without requiring any money down from the lessee. This helps the lessee conserve scarce cash—an especially desirable feature for new and developing companies. In addition, lease payments often remain fixed, which protects the lessee against inflation and increases in the cost of money. 2- Reduces risk of obsolescence to the lessee, and in many cases passes the risk of the residual value to the lessor 3 - Lease agreements may contain less restrictive provisions than other debt agreements. Innovative lessors can tailor a lease agreement to the lessee's special needs. For instance, the duration of the lease—the lease term—may be anything from a short period of time to the entire expected economic life of the asset. In many cases, the rent is set to enable the lessor to recover the cost of the asset plus a fair return over the life of the lease. 4 - Some companies find leasing cheaper than other forms of financing. For example, start-up companies in depressed industries or companies in low tax brackets may lease to claim tax benefits that they might otherwise lose. Depreciation deductions offer no benefit to companies that have little if any taxable income. Through leasing, the leasing companies or financial institutions use these tax benefits. They can then pass some of these tax benefits back to the user of the asset in the form of lower rental payments

What are the 3 categories of lessors?

1) Banks. Banks are the largest players in the leasing business. They have low-cost funds, which give them the advantage of being able to purchase assets at less cost than their competitors. Banks have been aggressive in the leasing markets. Deciding that there is money to be made in leasing, banks have expanded their product lines in this area. Finally, leasing transactions are now quite standardized, which gives banks an advantage because they do not have to be as innovative in structuring lease arrangements. 2) Captive leasing companies. Captive leasing companies are subsidiaries whose primary business is to perform leasing operations for the parent company. Captive leasing companies have the point-of-sale advantage in finding leasing customers. That is, as soon as Caterpillar receives a possible equipment order, its leasing subsidiary can quickly develop a lease-financing arrangement. Furthermore, the captive lessor has product knowledge that gives it an advantage when financing the parent's product. The current trend is for captives to focus primarily on their companies' products rather than execute general lease financing. 3) Independents. Their market share has dropped fairly dramatically as banks and captive leasing companies have become more aggressive in the lease-financing area. Independents do not have point-of-sale access, nor do they have a low cost of funds advantage. What they are often good at is developing innovative contracts for lessees. In addition, they are starting to act as captive finance companies for some companies that do not have leasing subsidiaries.

What are the 4 various views on capitalization of leases?

1) Do not capitalize any leased assets. This view considers capitalization inappropriate because Delta does not own the property. Furthermore, a lease is an "executory" contract requiring continuing performance by both parties. Because companies do not currently capitalize other executory contracts (such as purchase commitments and employment contracts), they should not capitalize leases either. 2) Capitalize leases that are similar to installment purchases. This view holds that companies should report transactions in accordance with their economic substance. Therefore, if companies capitalize installment purchases, they should also capitalize leases that have similar characteristics. For example, Delta makes the same payments over a 10-year period for either a lease or an installment purchase. Lessees make rental payments, whereas owners make mortgage payments. 3) Capitalize all long-term leases. This approach requires only the long-term right to use the property in order to capitalize. This property-rights approach capitalizes all long-term leases. 4) Capitalize firm leases where the penalty for nonperformance is substantial. A final approach advocates capitalizing only "firm" (non-cancelable) contractual rights and obligations. "Firm" means that it is unlikely to avoid performance under the lease without a severe penalty

To apply the present value test, a lessee must determine the amount of lease payments and the appropriate discount rate. What 4 things do the lease payments generally include?

1) Fixed payments. These are the rental payments that are specified in the lease agreement and fixed over the lease term. 2) Variable payments that are based on an index or a rate. The lessee should include variable lease payments in the value of the lease liability at the level of the index/rate at the commencement date. When valuing the lease liability, no increases or decreases to future lease payments should be assumed based on increases or decreases in the index or rate. Instead, any difference in the payments due to changes in the index or rate is expensed in the period incurred. 3) Amounts guaranteed by a lessee under a residual value guarantee. 4) Payments related to purchase or termination options that the lessee is reasonably certain to exercise. As indicated earlier, if the lease contains a bargain purchase option, the cost of that option should be considered part of the lease payments.

What are the 4 advantages of leasing from the perspective of the lessor?

1) It often provides profitable interest margins. 2) It can stimulate sales of a lessor's product whether it be from a dealer (lessor) or manufacturer (lessor) 3) It often provides tax benefits to various parties in the lease, which enhances the return to all parties involved, including the lessor. To illustrate, Boeing Aircraft might sell one of its 737 jet planes to a wealthy investor who does not need a plane but could use the tax benefit. The investor (the lessor) then leases the plane to a foreign airline, for which the tax benefit is of no use. Everyone gains. Boeing sells its airplane, the investor receives the tax benefit, and the foreign airline receives a lower rental rate because the lessor is able to use the tax benefit. 4) It can provide a high residual value to the lessor upon the return of the property at the end of the lease term.

What are the 5 lease classification tests?

1) Transfer of ownership test. If ownership is transferred to the lessee, it is a finance lease. 2) Purchase option test. A purchase option test is met if it is reasonably certain that the lessee will exercise the option. In other words, the lease purchase option allows the lessee to purchase the property for a price that is significantly lower than the underlying asset's expected fair value at the date the option becomes exercisable (hereafter referred to as a bargain purchase option). 3) Lease term test. That is, if the lease term is 75 percent or greater of the economic life of the leased asset, the lease meets the lease term test and finance lease treatment is appropriate (often referred to as the 75% test). Essentially, lease term/economic life = 75%. Also must consider bargain renewal option, bargain renewal option allows the lessee to renew the lease for a rental that is lower than the expected fair rental at the time the option becomes exercisable. At the commencement of the lease, the difference between the renewal rental and the expected fair rental must be great enough to make exercise of the option to renew reasonably certain.3 Thus, companies should include in the lease term any bargain renewal periods. Example: For example, assume that Home Depot leases Dell PCs for two years at a rental of $100 per month per computer. In addition, Home Depot can lease these computers for $10 per month per computer for another two years. The lease clearly offers a bargain renewal option, and Home Depot should consider the lease term for these computers to be four years, not two. 4) Present value test: This guideline states that if the present value of the lease payments equals or exceeds 90 percent of the fair value of the asset, then a lessee should use the finance method to record the lease 5) Alternate use test: f at the end of the lease term the lessor does not have an alternative use for the asset, the lessee classifies the lease as a finance lease. In this situation, the assumption is that the lessee uses all the benefits from the leased asset and therefore the lessee has essentially purchased the asset. Lessors sometimes build an asset to meet specifications set by the lessee (referred to as "build-to-suit" arrangements). For example, an equipment manufacturer might build hydraulic lifts to meet unique loading dock configurations of a lessee, like Amazon.com. Given the specialty nature of the equipment, only Amazon can use the lifts and it receives substantially all of the benefits of the leased asset, such that the alternative use test is met.

What are the guidelines for accounting for a guaranteed residual value?

1. If it is probable that the expected residual value is equal to or greater than the guaranteed residual value, the lessee should not include the guaranteed residual value in the computation of the lease liability. 2. If it is probable that the expected residual value is less than the guaranteed residual value, the difference between the expected and guaranteed residual values should be included in computation of the lease liability.

One thing is certain—the grossing up of the assets and liabilities related to lease arrangements will have significant consequences on the organizational, operational, and contractual side. Examples are:

1. States often levy taxes based on property amounts, which will now be higher. 2. Performance metrics to evaluate management may have to change for companies, particularly when growth rates in assets are used or returns on assets are used to measure performance. 3. Companies may have contracts with the government for which reimbursement is based on rent expense, which may change the compensation agreement. 4. Debt covenants might require revisions.

What is a lease, and what are the rights of the lessee and lessor?

A lease is a contractual agreement between a lessor and a lessee. This arrangement gives the lessee the right to use specific property, which is owned by the lessor, for a specified period of time. In return for the use of the property, the lessee makes rental payments over the lease term to the lessor. A lease is defined as a "contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment (an identified asset) for a period of time in exchange for consideration." A lease therefore conveys the use of an asset from one party (the lessor) to another (the lessee) without transferring ownership. Accounting for lease transactions is controversial, as the following example illustrates.

What is the lessee perspective of an unguaranteed residual value?

A lessee does not include an unguaranteed residual value in the computation of the lease liability, whether it is a finance lease or an operating lease. At the end of the lease, the lessee simply returns the leased asset to the lessor without any other payment

Under a finance lease, how does a lessee report interest expense and amortization of the right of use asset?

A lessee therefore reports both interest expense and amortization of the right-of-use asset on the income statement. As a result, the total expense for the lease transaction is generally higher in the earlier years of the lease arrangement under a finance lease arrangement.

What are executory costs?

Executory costs are normal expenses associated with owning a leased asset, such as property insurance and property taxes. The accounting for executory costs depends on how the lease is structured, that is, whether the lease is a gross lease or a net lease. In a gross lease, the payments to the lessor are fixed as part of the rental payments in the contract. In a net lease, the lessee makes variable payments to a third party or to the lessor directly for the executory costs. Illustration 21.29 provides examples of these two situations. Note that including executory costs in the measurement of the lease liability and related right-of-use asset may lead to inflated values on the balance sheet in comparison to lessees who do not capitalize these costs. Thus, the way parties structure the payment of executory costs (i.e., variable or fixed) can have potentially material implications with regard to the values that appear on the balance sheet. In summary, executory costs included in the fixed payments required by the lessor should be included in lease payments for purposes of measuring the lease liability. Payments by the lessee made directly to the taxing authority or insurance provider are considered variable payments and are expensed as incurred.

How does a lessor account for operating leases versus sales-type leases?

For operating leases, a lessor defers the initial direct costs and amortizes them as expenses over the term of the lease. For sales-type leases, the lessor expenses initial direct costs at lease commencement (in the period in which it recognizes the profit on the sale). An exception is when there is no selling profit or loss on the transaction. If there is no selling profit or loss, the initial direct costs are deferred and recognized over the lease term. ****Lessors commonly also incur internal costs related to leasing activities. Examples are activities the lessor performs for advertising, servicing existing leases, and establishing and monitoring credit policies, as well as the costs for supervision and administration or for expenses such as rent and depreciation. Internal direct costs should not be included in initial direct costs. Such costs would have been incurred regardless of whether a lease was executed. As a result, internal direct costs are generally expensed as incurred.

What is the main difference between an operating and finance lease in regards to ownership?

If the lease transfers control (or ownership) of the underlying asset to a lessee, then the lease is classified as a finance lease. In this situation, the lessee takes ownership or consumes the substantial portion of the underlying asset over the lease term. All leases that do not meet any of the finance lease tests are classified as operating leases. In an operating lease, a lessee obtains the right to use the underlying asset but not ownership of the asset itself.

What is the summary for accounting treatment of guaranteed and unguaranteed residual values from perspective of lessor?

Ignore the unguaranteed residual value for the classification test, but include for measurement of receivable. Include teh guaranteed residual value in both classification test and measurement of receivable.

Residual value is the expected value of the leased asset at the end of the lease term. A residual value can be guaranteed or unguaranteed. What are these differences?

In a guaranteed residual value, the lessee has an obligation to not only return the leased asset at the end of the lease term but also to guarantee that the residual value will be a certain amount. If the lease involves an unguaranteed residual value, the lessee does not have any obligation to the lessor at the end of the lease, except to return the leased asset to the lessor.[5] For classification purposes, the lessee includes the full amount of the residual value guarantee at the end of the lease term in the present value test. The lessee does not consider unguaranteed residual value as part of the present value test.

In what type of leases do companies capitalize all leased assets and liabilities?

In both an operating and finance lease. Therefore, the balance sheet for a company that uses either a finance lease or an operating lease will be the same. However, for income statement purposes, the reporting of financial information depends on whether the lease is classified as a finance lease or operating lease.

What are initial direct costs?

Incremental costs of a lease that would not have been incurred has the lease not been executed. Costs directly or indirectly attributable to negotiating and arranging the lease (e.g., external legal costs to draft or negotiate a lease or an allocation of internal legal costs) are not considered initial direct costs. Costs included from initial direct: Commissions (including payments to employees acting as selling agents) Legal fees resulting from the execution of the lease Lease document preparation costs incurred after the execution of the lease Consideration paid for a guarantee of residual value by an unrelated third party Costs excluded: Employee salaries Internal engineering costs Legal fees for services rendered before the execution of the lease Negotiating lease term and conditions Advertising Depreciation Costs related to an idle asset ****Initial direct costs incurred by the lessee are included in the cost of the right-of-use asset but are not recorded as part of the lease liability.

What is the type of quantitative information that should be disclosed for the lessor?

Lease-related income, including profit and loss recognized at lease commencement for sales-type and direct financing leases, and interest income. Income from variable lease payments not included in the lease receivable. The components of the net investment in sales-type and direct financing leases, including the carrying amount of the lease receivable, the unguaranteed residual asset, and any deferred profit on direct financing leases. A maturity analysis for operating lease payments and a separate maturity analysis for the lease receivable (sales-type and direct financing leases). Management approaches for risk associated with residual value of leased assets (e.g., buyback agreements or third-party insurance).

What happened as a result of implementing the new standard on leasing?

Many companies that lease are likely to see their balance sheets grow substantially over the next few years as a result of implementing the new standard on leasing. Estimates as to its dollar impact on the assets and liabilities of companies vary, but it will be in the trillions of dollars Some contend that "grossing up" the assets and liabilities on companies' balance sheets will not have any significant impact on analysis, based on information in the financial statements. Their rationale is that stockholders' equity does not change substantially, nor will net income. In addition, it is argued that users can determine the obligations that lessees are incurring by examining the notes to the financial statements. With the increase in the assets and liabilities as a result of the new standard, a number of financial metrics used to measure the profitability and solvency of companies will change, which could create challenges when performing financial analysis. On the profitability side, return on assets will decrease because a company's assets will increase, but net income will often be the same. Furthermore, analysts commonly focus on income subtotals, such as earnings before interest, taxes, and depreciation and amortization (EBIDTA), which likely will require some adjustments as companies amortize right-of-use assets. On the solvency side, the debt to equity ratio will increase, and the interest coverage ratio will decrease. In addition, recent studies indicate that using only note disclosures to determine lease obligations have understated their numerical impact

How does the lessor report information related to sales-type (finance) and operating lease?

Sales type lease: 1) Balance sheet = lease receivable presented separate from other assets and derecognize the leased asset 2) Income statement = interest revenue and selling profit or loss operating lease: 1) Balance sheet = continue to recognize assets subject to operating leases as PPE 2) Income statement = revenue generally recognized on a straight line basis and depreciation expense on the leased asset

What must a lessee do if a bargain purchase option exists?

The lessee must increase the present value of the lease payments by the present value of the option price. The only difference between the accounting treatment for a bargain purchase option and a guaranteed residual value of identical amounts and circumstances is in the computation of the annual amortization. In the case of a guaranteed residual value, lessee amortizes the right-of-use asset over the lease term. In the case of a bargain purchase option, it uses the economic life of the underlying asset, given that the lessee takes ownership of the asset.

Why are the lease classification tests for the lessor identical to the tests used by the lessee?

The reason is that the tests are used to determine whether the lessee and the lessor have an agreement to transfer control of the asset from one party to the other. If the lessee receives control, then the lessor must have given up control. The FASB concluded that by meeting any of the lease classification tests in Illustration 21.6, the lessor transfers control of the leased asset and therefore satisfies a performance obligation, which is required for revenue recognition under the FASB's recent standard on revenue.[10] That is, the lessor has, in substance, transferred control of the right-of-use asset and therefore has a sales-type lease if the lessee takes ownership or consumes a substantial portion of the underlying asset over the lease term. On the other hand, if the lease does not transfer control (and ownership) of the asset over the lease term, the lessor will generally use the operating approach in accounting for the lease.[11] Although not part of the classification tests, the lessor must also determine whether the collectibility of payments from the lessee is probable. If payments are not probable, the lessor does not record a receivable and does not derecognize the leased asset. Instead, receipt of any lease payments is recorded as a deposit liability

What is the lessor perspective on an unguaranteed residual value?

Therefore, the lessor recognizes sales revenue and cost of goods sold only for the portion of the asset for which recovery is assured. To account for this uncertainty, both sales revenue and cost of goods sold are reduced by the present value of the unguaranteed residual value. Given that the amount subtracted from sales revenue and cost of goods sold are the same, the gross profit computed will still be the same amount as when a guaranteed residual value exists. Caterpillar records the same gross profit ($15,000) at the point of sale whether the residual value is guaranteed or unguaranteed. However, the amounts recorded for sales revenue and the cost of goods sold are different between the guaranteed and unguaranteed situations. The reason for the difference is the uncertainty surrounding the realization of the unguaranteed residual value. Unlike the guaranteed residual value situation, where the lessor knows that it will receive the full amount of the guarantee at the end of the lease, in an unguaranteed residual value situation the lessor is not sure what it will receive at the end of the lease regarding the residual value. That is, due to the uncertainty surrounding the realization of the unguaranteed residual value, sales revenue and related cost of goods sold are reduced by the present value of the residual value. This results in the sales revenue and cost of goods sold amounts being reported at different amounts under an unguaranteed residual value situation.

Why must lessees and lessors provide additional qualitative and quantitative disclosures?

To help financial statement users assess the amount, timing, and uncertainty of future cash flows. These disclosures are intended to supplement the amounts provided in the financial statements.

What is the summary for accounting treatment of guaranteed and unguaranteed residual values from perspective of lessee?

Under the classification and measurement of liability, ignore unguaranteed residual value. Include the full amount of residual value in present value test. - If expected value of residual value >/= to guaranteed residual value, ignore - If expected value of residual value </= to guaranteed residual value, include the present value of the difference between the expected and guaranteed residual value in computation of lease liability

What happens upon expiration of the lease?

Upon expiration of the lease, the lessee has fully amortized the amount capitalized as a right-of-use asset. It also has fully discharged its lease obligation. At the date the lease expires, both the right-of-use asset account and lease liability account related to the lease of the backhoe have zero balances.

When computing the present value of the lease payments, what rate does the lessee use?

Use the implicit interest rate as the discount rate. This rate is defined as the discount rate that, at commencement of the lease, causes the aggregate present value of the lease payments and unguaranteed residual value to be equal to the fair value of the leased asset. A lessee may find that it is impracticable to determine the implicit rate of the lessor. In the event that it is impracticable to determine the implicit rate, Delta uses its incremental borrowing rate. The incremental borrowing rate is the rate of interest the lessee would have to pay on a similar lease or the rate that, at commencement of the lease, the lessee would incur to borrow over a similar term the funds necessary to purchase the asset. The implicit rate of the lessor is generally a more realistic rate to use in determining the amount to report as the asset and related liability for Delta. However, given the difficulty the lessee may have in determining the implicit rate, it is likely that the lessee will use the incremental borrowing rate

What happens if the fair value of the underlying asset is less than the expected residual value?

Will record a loss on lease as part of residual value guarantee

Which of the 3 previous approaches has the FASB adopted?

he FASB has recently adopted the third approach, which requires companies to capitalize all long-term leases. The only exception to capitalization is that leases covering a term of less than one year do not have to be capitalized. The FASB indicates that the right to use property under the terms of the lease is an asset, and the lessee's commitment to make payments under the lease is a liability. So, lessee records a right of use asset on their balance sheet and a liability for its obligation to make payments under the lease.

When computing the present value test and measuring the lease liability, do you always include the guaranteed residual value?

the present value test includes the full amount of the residual value guarantee to determine whether the lease is classified as a financing or operating lease. However, for measurement of the lease liability, Sterling includes only the expected residual value probable of being owed by the lessee under the residual value guarantee. Because Sterling believes that it is probable that the expected residual value will be greater than the guaranteed residual value, the guaranteed residual value is not included in the measurement of the lease liability