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3.5 Variable interests—leases
Publication date: 31 Jul 2022
us Consolidation guide
Guidance on how to apply the VIE model to leases is found in ASC 810-10-55-39.
Receivables under an operating lease are assets of the lessor entity and provide returns to the lessor entity with respect to the leased property during that portion of the asset’s life that is covered by the lease. Most operating leases do not absorb variability in the fair value of a VIE’s net assets because they are a component of that variability. Guarantees of the residual values of leased assets (or similar arrangements related to leased assets) and options to acquire leased assets at the end of the lease terms at specified prices may be variable interests in the lessor entity if they meet the conditions described in paragraphs 810-10-25-55 through 25-56. Alternatively, such arrangements may be variable interests in portions of a VIE as described in paragraph 810-10-25-57. The guidance in paragraphs 810-10-55-23 through 55-24 related to debt instruments applies to creditors of lessor entities.
When evaluating whether a lease is a variable interest, reporting entities should consider, among other things, whether the lease is an operating lease, as well as whether there are other features that are designed to absorb the economic variability of a VIE. Further, embedded leases should also be assessed to determine whether they represent variable interests.
3.5.1 Variable interests—entity is the lessor
Lease receivables of the lessor entity are not variable interests. Rather, receivables from operating leases create variability in the entity’s operations and fair value.
The following embedded features included in operating leases may be variable interests:
- Lessee purchase options
A fixed-price or formula-based purchase option is a variable interest in the asset because it provides the holder of that option with the potential to purchase the asset at a price that is less than fair market value. Effectively, if the purchase option is exercised, the lessor entity’s equity investors would not receive all of the asset’s expected residual returns. If the purchase option were on assets that comprise less than 50% of the fair value of the lessor entity’s total assets, the purchase option would not be a variable interest in the lessor entity as a whole; rather, it would be a variable interest in specified assets. Consideration should also be given to whether the purchase option, in combination with other interests, create a “silo” within a VIE. See CG 3.7 through CG 3.8 for further discussion on variable interests in specified assets and silos. - Lessee residual value guarantees
In many leasing arrangements, the lessee provides a residual value guarantee on the leased asset. A residual value guarantee is a variable interest because it protects the lessor entity’s equity investors from negative variability in the fair value of the leased asset (i.e., the equity investors do not have the obligation to absorb all of the entity’s economic risks). If the residual value guarantee covers only specified assets that comprise less than 50% of the fair value of the lessor entity’s total assets, it would not be a variable interest in the lessor entity; rather it would be a variable interest in specified assets. Consideration should also be given to whether the residual value guarantee, in combination with other interests, create a “silo” within a VIE. See CG 3.7 through CG 3.8 for further discussion on variable interests in specified assets and silos. - Lessee renewal options
Renewal options in leases with rental payments at an amount other than fair value may be variable interests in the lessor entity. If a lease includes one or more renewal options, and those renewal options are not included in the lease term, as defined in ASC 842-10-20, the renewal option is a variable interest because it provides the lessee with the right to lease the assets for a period beyond the original lease term for rental payments that potentially differ from fair value. Thus, the renewal option captures a portion of the residual value of the asset.
If the lease renewal option is for specified assets that comprise less than 50% of the fair value of the lessor entity’s total assets, the renewal option would not be a variable interest in the entity; rather, it would be a variable interest in specified assets. - Lease prepayments to the lessor
Lease prepayments to a lessor entity are in substance a loan that will be repaid over the term of the leased asset. Because a loan is generally a variable interest in the debtor, lease prepayments similarly should be considered a variable interest in the lessor entity.
See CG 5.1 for primary beneficiary analysis, particularly with respect to certain single asset owning special purpose entities (lessor entities).
3.5.2 Variable interests—entity is the lessee
When the entity is the lessee, the lease should be treated like a debt instrument since these arrangements are, in essence, financing arrangements. That is, the reporting entity (lessor) would generally be viewed as having a variable interest in the entity to which it leases an asset.
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