Essential Equipment Lease Terms for Better Lease Management

Types of Equipment Leases

Under ASC 842, leases are classified as finance leases or operating leases. Here are the common types:

• Fair Market Value (FMV) Lease: Treated as an operating lease if it doesn’t meet finance lease criteria. Lessees record the right-of-use asset and liability.
• $1 Buyout Lease: Generally classified as a finance lease since ownership is transferred for a nominal fee.
• Operating Lease: Recorded on the balance sheet with straight-line expense recognition over the term.
• Finance Lease: Transfers ownership or includes purchase options, capitalized on the balance sheet with separate amortization and interest expenses.
• Lease-to-Own: Typically a finance lease due to the transfer of ownership at the end of the term.
• Sale-Leaseback: A transaction recorded as a financing arrangement if the sale criteria under ASC 842 aren’t met.
• Master Lease Agreement: Each piece of equipment is evaluated under ASC 842 for classification and reporting requirements.

1. Base Rent (Minimum Rent)

The fixed payment due for the lease. Under ASC 842, it forms part of the lease liability calculation.
Example: A lessee pays $1,000 monthly as base rent for equipment.

2. Lease Commencement Date

The date when the lease term starts. This marks the recognition of the right-of-use asset and lease liability.
Example: A lease starts on January 1, 2025, for accounting under ASC 842.

3. Rent Commencement Date

The date on which rent payments begin. ASC 842 requires aligning payment schedules with the lease liability.
Example: Rent payments start 30 days after lease commencement.

4. Lease Term

The period over which the lessee has control of the asset. ASC 842 includes renewal or termination options if reasonably certain to be exercised.
Example: A three-year lease with a one-year renewal option included in calculations.

5. Operating Expenses (OPEX)

Costs for using the asset, such as maintenance, that may be excluded from the lease liability.
Example: Monthly maintenance costs of $500 for construction equipment.

6. Maintenance Obligations

ASC 842 differentiates maintenance agreements from lease components.
Example: Maintenance services are separated from lease payments for accounting.

7. Fair Market Value (FMV) Lease

Classified as an operating lease unless it transfers ownership or meets other finance lease criteria.
Example: An FMV lease for IT equipment recorded as an operating lease.

8. $1 Buyout Lease

Typically a finance lease due to the transfer of ownership.
Example: A $1 buyout lease for industrial machinery is recorded as a financed asset.

9. Percentage Rent

An additional rent based on revenue, treated as variable payments under ASC 842.
Example: Lessee pays 2% of monthly sales for vending machines.

10. Security Deposit

A refundable payment, not included in the lease liability under ASC 842.
Example: A $2,000 deposit held for leased medical devices.

11. Equipment Upgrade Option

Options are analyzed for inclusion in lease terms.
Example: Mid-term hardware upgrade fees excluded from lease liability.

12. Sublease and Assignment

Subleases are separately classified under ASC 842 as operating or finance leases.
Example: A lessee subleasing manufacturing equipment must disclose sublease terms.

13. Escalation Clause

Fixed escalations are included in lease liability calculations; variable costs are not.
Example: A 3% annual increase impacts liability schedules.

14. Early Termination Clause

ASC 842 considers penalties if termination is reasonably certain.
Example: Termination penalties are included in lease liability if applicable.