Revenue, taxes, and leases
The Lease Test
Any one of the five criteria makes it a finance lease, and under ASC 842 either kind goes on the balance sheet.
How the exam words it
- -The stem lists lease facts (term versus economic life, PV versus fair value, purchase option, specialized asset) and asks 'how should this lease be classified?'.
- -It asks 'what is recorded on the balance sheet at commencement', often for an operating lease.
- -It asks for interest expense in a later year of a finance lease, or the straight-line expense when rents are uneven or a period is free.
- -The term is under twelve months and the short-term exception is in play.
The playbook
- 1Run the five tests: ownership transfers, purchase option reasonably certain, term is a major part (75 percent) of economic life, PV of payments is substantially all (90 percent) of fair value, or the asset is specialized with no alternative use. Any one met = finance lease.
- 2Both types record an ROU asset and lease liability at the PV of payments; only a short-term lease (12 months or less, no purchase option) may stay off the balance sheet.
- 3Finance leases report amortization plus interest on the outstanding liability balance; operating leases report one straight-line lease expense.
- 4Straight-line uneven rents: total payments divided by the term, regardless of the cash pattern.
The trap
Leaving an operating lease off the balance sheet. Under ASC 842 both operating and finance leases record an ROU asset and liability; only the expense pattern differs.
How the exam varies it
The same pattern, re-skinned along these axes:
Classification versus initial measurement versus subsequent expenseWhich of the five criteria decides itEven versus uneven payments, and the short-term exception
Drill this pattern
8 questions of The Lease Test from across the AUD topics. Clear it by getting 5 right with a streak of 3.