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3.4 Application of the “reasonably certain” threshold
Publication date: 31 May 2023
us Leases guide
Reasonably certain should be considered a high threshold. While there are no bright lines, the FASB has indicated that the threshold is similar to “reasonably assured” in existing GAAP, which implies a probability of 75%. An assessment of whether a lessee is reasonably certain to exercise a renewal, termination, or purchase option should consider the substance rather than the legal form of the contract.
An entity should assess whether it is reasonably certain that the lessee will exercise an option by considering all factors relevant to that assessment, including contract-, asset-, market-, and entity-based factors. Certain factors, such as economic penalties, may make exercise of a renewal, termination, or purchase option reasonably certain of exercise. Factors to consider include:
- Whether the purpose or location of the asset is unique
- The availability of comparable replacement assets
- For real estate leases, the cost of moving to another location and any related disruption to operations
- For equipment leases, the cost of any disruption to operations that would be experienced by changing equipment
- The contractual terms associated with extending or terminating the lease term; for example, the lease payments during a renewal period, any termination payments, and whether those payments are fixed, variable, or contingent
- The importance of the leased asset to the lessee’s operations; for example, a headquarters building might be so closely associated with the lessee’s image that it makes the possibility of relocation remote, or a particular facility or unit of equipment might be so integral to a manufacturing process that either purchase or continuation of the lease is reasonably certain
- Leasehold improvements or other assets whose value would be impaired if the lessee were to relocate or cease use of the leased asset
- Punitive tax consequences when an option is exercised (or not exercised) to purchase the underlying asset, renew the lease term, or terminate the lease prior to the stated expiration date
Depending on the information available, a lessor and a lessee may arrive at different conclusions as to whether certain options appear reasonably certain to be exercised. Lessors will typically have less knowledge of lessee-specific factors, which may impact their analysis.
See LG 3.3.2 and LG 3.3.3 for information on economic penalties and purchase, renewal, and termination options. See LG 3.3.4.4 for information on how guarantees impact the assessment of this criterion. See ASC 842-10-55-26 for additional examples of economic factors to consider.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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