When would I need to reassess a lease classification?

Mid-Term Lease Classification Changes

What is a mid-term lease classification change?

In the event of a significant change in the terms of a lease agreement or a shift in economic conditions surrounding the lease arrangement, it is necessary for the lessee to reevaluate the lease classification. Factors such as changes in the lease term, purchase options, or transfer of ownership can prompt a reassessment to determine whether the lease should be classified as a finance lease or an operating lease.

Why is it important?

ASC 842, IFRS 16 and GASB 87 accounting standards provide guidelines for the classification of leases. The classification is important for financial reporting purposes, as it affects how the lease is treated on the lessee's financial statements.

Classification Change	Income Statement Impact
Finance→ Operating	Any difference between the carrying amount of the ROU Asset after recording the remeasurement adjustment and the carrying amount of the ROU Asset that would have resulted from initially classifying the lease as an operating lease should be accounted for like a rent prepayment or a lease incentive.
Operating → Finance	If a lease is classified as a finance lease upon remeasurement (regardless of the classification before remeasurement), a lessee should calculate interest expense on the lease liability based on the discount rate at the remeasurement date. The ROU Asset amortization expense should be determined by calculating a new straight-line amortization amount using the revised ROU Asset value and lease term.
Short-Term →Finance	Interest and depreciation expenses are recognized on the income statement. Total expense over the lease term is higher than a short-term lease due to the recognition of interest.
Short-Term→ Operating	Both of these classifications take into account fixed rental payments on a straight-line basis. However, operating leases have a longer duration as they are not considered short-term leases. Short-term leases < 12 Months Operating leases > 12 Months

When would I need to reassess classification?

Modification Type	Reassess for definition of a lease	Reallocate Contract Consideration	Update Discount Rate	Reassess Classification	Remeasure the lease liability and adjust ROU Asset
Contract Modification	X	X	X	X	X
Change in Lease Term		X	X	X	X
Change in Purchase Option Assessment		X	X	X	X
Contingency Resolution ex: variable payments become lease payments due to contingency resolution		X			X
Change in Residual Value Guarantee		X			X

To gain more insight on this topic, you can refer to the following article: "How do I reassess the lease classification?"

How can Occupier help?

When a modification event results in a change to the lease classification, Occupier is here to help by seamlessly incorporating the change in lease classification into a single lease record. Occupier ensures all reporting captures the change in classification. In addition, Occupier maintains all the accounting data prior to the modification, which can be easily reviewed when exporting the amortization schedules to Excel.