6.8 Costs Imposed to Dismantle and Remove an Underlying Asset at End of Lease Term

A lessee may need to incur certain costs at the end of the lease term so that the lessee may return the asset to the lessor in accordance with the lease agreement. Those costs are generally considered to be either of the following:

• Lease payments, because the costs, which benefit the lessor and not the lessee, are imposed by the lease agreement and incurred to restore functionality of the leased asset or to dismantle or remove the actual underlying asset for return to the lessor (further discussed below).
• Asset retirement obligations in accordance with ASC 410-20, because the costs are incurred to remove lessee installations (e.g., leasehold improvements) so that the lessee may restore the underlying asset to its original condition (see Section 6.9.4).

In certain situations, a lessee may agree to pay for the costs of removing and returning leased equipment to the lessor at the end of the lease. In such circumstances, the lessee would be required to include its best estimate of those costs in the lease payments at lease commencement. For example, for an asset being leased, such as manufacturing equipment that must be returned to the lessor at the end of the lease, the amount that the lessee expects to incur to ship or otherwise return the manufacturing equipment to the lessor would be included in the lease payments.

 

Connecting the Dots

Costs of Dismantling and Removing an Underlying Asset

Although costs imposed to dismantle and remove an underlying asset at the end of the lease term should generally be included in lease payments, obligations to return an underlying asset to its original condition would not qualify as lease payments. See Section 6.9.4 for further discussion.

In addition, if the costs will vary on the basis of how much the lessee uses the asset during the lease term, such costs are considered to be variable lease payments and therefore are not estimated at lease commencement.