5.3 Lease Receivables
Unlike receivables arising from operating leases (see Section 2.2 for more
information), net investments resulting from sales-type or direct financing leases are
within the scope of ASC 326 and lessors will therefore need to determine expected credit
losses for such instruments.
The net investment in a lease primarily comprises a financial lease
receivable (i.e., the unguaranteed residual asset is often insignificant) and therefore
should be accounted for as a financial asset under ASC 310. Thus, although the
unguaranteed residual asset included in a lessor’s net investment in a lease does not
meet the definition of a financial asset, a lessor will be required to apply the CECL
model to the net investment in the lease, including both the lease receivable and the
unguaranteed residual asset.
5.3.1 Measuring Expected Credit Losses on a Net Investment in a Lease
ASC 842-30-35-3 provides guidance on how a lessor should
determine an impairment related to a net investment in a lease. According to
that guidance, when a lessor performs its evaluation, the collateral it
considers should include the cash flows that the lessor would expect to derive
from the underlying asset after the end of the lease term. Specifically, ASC
842-30-35-3 states:
A lessor shall determine the loss
allowance related to the net investment in the lease and shall record any
loss allowance in accordance with Subtopic 326-20 on financial instruments
measured at amortized cost. When determining the loss allowance for a net
investment in the lease, a lessor shall take into consideration the
collateral relating to the net investment in the lease. The collateral
relating to the net investment in the lease represents the cash flows that the lessor would expect to receive (or
derive) from the lease receivable and the unguaranteed residual
asset during and following the end of the remaining lease term. [Emphasis
added]
The unit of account used when the impairment model is applied
from the lessor’s perspective is meant to encompass the amounts related to the
entire net investment in the lease, including the residual asset. Therefore,
when evaluating the net investment in a sales-type or direct financing lease for
impairment, a lessor should use the cash flows it expects to derive from the
underlying asset during the remaining lease term as well as those it expects to
derive from the underlying asset at the end of the lease term (i.e., cash flows
expected to be derived from the residual asset). When determining the cash flows
to be derived from the residual asset, the lessor should consider the amounts it
would receive for releasing or selling the underlying asset to a third party but
should not consider the expected credit risk of the potential future lessee or
buyer of the underlying asset (i.e., it would not be appropriate for the lessor
to include a credit risk assumption in its analysis since it does not know the
identity of the theoretical future lessee or buyer).
5.3.2 Gains and Losses on Subsequent Dispositions of Leased Assets
When measuring expected credit losses on a portfolio of net
investment in leases, an entity should consider gains arising from the
subsequent disposition of leased assets.
At the June 2018 TRG meeting, the FASB staff
stated that “entities should estimate expected cash flows from the subsequent
disposition of leased assets (whether those result in expected gains or losses
on disposal) when calculating expected credit losses on a portfolio of net
investments in leases under the guidance in Subtopic 326-20 if that estimate is
reasonable and supportable consistent with the treatment of other inputs to the
calculation of expected credit losses.” That is, the FASB staff does not view
the pool-level assessment required under ASC 326-20 as precluding the inclusion
of “cash flows from the subsequent disposition of leased assets expected to
result in gains on disposal from the calculation of expected credit losses.”4
However, we believe that the inclusion of expected gains on the
disposal of leased assets should not, by itself, cause an entity’s allowance for
expected credit losses to be negative. That is, while an entity should include
in its estimate of expected credit losses the cash flows expected upon the
disposition of the leased assets, we believe that the amount of cash flows
related to gains on the disposal of such assets should be limited to the amount
necessary to offset any expected credit losses on the lease payments.
Example 5-5
Lessor’s portfolio of sales-type leases
has a net investment balance of $6 million. On the basis
of its historical experience and its reasonable and
supportable forecasts, Lessor estimates that 4 percent
will default. Given the projected net investment balance
at the time of the defaults and the estimated proceeds
from the disposition of the leased assets, Lessor
expects $200,000 of credit losses. In addition, it
expects to recover $50,000 from the sale of the assets
included in its performing leases (i.e., those that will
not default during the lease term). On the basis of the
FASB staff’s response at the TRG meeting, Lessor would
estimate its expected credit losses as the sum of (1)
its expected credit losses resulting from expected
defaults plus (2) the gains it expects to recover from
the disposition of assets on the leases that do not
default. That is, Lessor’s expected credit losses would
be $150,000, calculated as the net amount expected to be
collected at the pool level.
Footnotes
4
See TRG Memo 7.