Demystifying Asset Leasing Classifications: Lease Types

While configuring the Asset Leasing module you may have noticed the many thresholds and setups included in the lease book setup. These threshold tests are critical for ensuring the system will classify leases appropriately under the applicable standard. This blog will dive deeper into the thresholds used to classify leases as finance or operating under ASC 842 and IFRS 16 and is part of a larger series of blogs written to explain the many classifications of the Asset Leasing module.

Note: This blog post does not intend to give advice on the accounting standards. This blog post is intended to inform the user of the behavior of the Asset Leasing module in order to configure and use the module in the way the user wishes to comply with the standards.

Lease Type Classification

 This blog will cover specifically how the Lease type dropdown on the lease book setup drives the final lease type assigned on the book details. This is especially useful for US GAAP ASC 842 books as there is a complex decision tree the system follows to determine the final classification:

If the lease is not classified as either low-value or short-term, the Asset Leasing module will then look to the Lease type specified on the book setup to determine the classification of the lease.

Operating Lease Type: When the Lease type on the book setup is Operating, the lease will automatically be classified as an operating lease regardless of the inputs of the lease if not classified as low-value or short-term.

Finance Lease Type: When the Lease type on the book setup is Finance, the lease will automatically be classified as a finance lease regardless of the inputs of the lease if not classified as low-value or short-term.

Automatic:

 If the Lease type on the lease book setup is Automatic, the system will run through additional tests to determine the final lease classification. For IFRS 16 accounting frameworks, the final classification will be finance when the Lease type is Automatic.

However, because US GAAP ASC 842 still maintains two classifications, the Asset Leasing module will look at several variables and additional threshold tests to determine how to classify the lease. If any one of the following questions are true, then the ASC 842 lease will be classified as a finance type in the Asset Leasing module, else the lease will be classified as operating:

•  Is the Transfer of ownership field “Yes”

• Is the Lease term field divided by the Asset useful life field greater than or equal to the Lease term / Useful life (%) setup field on the book details?

Threshold setup (Book setup):

Lease term and Asset useful life (Book details):

The results of this calculation are shown on the Lease Classification Test fast tab of the Lease Book Details form:

• Is the Present value of lease payments from the payment schedule divided by the Fair value of the asset field greater than or equal to the Present value / Asset fair value (%) set up field?

 Threshold setup (Book setup):

Sum of present value (Payment schedule):

Fair value of the asset (Book details):

The results of this calculation are shown on the Lease Classification Test fast tab of the Lease Book Details form:

• Is the Unique asset field “Yes”?

Override Lease Classification

One last note on lease classification, you may have noticed while setting up the module there is a parameter labeled Allow manual classification override:

If this parameter is enabled, it will allow the user to select the Manual override toggle on the book details in the Lease Classification Test fast tab. When this toggle is enabled, the user must enter a reason for the override and will be able to choose a new lease type and even mark the lease as deferred rent treatment:

Tip: You must click Create Schedules after changing the lease classification to see the changes reflected on the schedules. It’s also important to note that the classification can only be overridden before the payment schedule is confirmed.

The Allow manual classification override parameter is powerful and should be restricted to only System Administrators to prevent users from classifying leases outside of company’s accounting policy unless there is a valid reason.

Final Thoughts

Overall, the Asset Leasing module runs a very complex algorithm in the backend to determine the final classification of a lease. Understanding this decision tree and how you wish to classify your leases will help in your decisions as you configure the application to meet your lease accounting needs. Especially under ASC 842, the Lease type field on the book setup will determine how you will structure your leasing setup. This decision will ultimately affect how you will enter leases and account for those leases. So, while it may be one small dropdown, it has an enormous final effect on your lease accounting.

By Brian Markgraf CPA, Crowe, a Microsoft Dynamics 365 Gold Partner https://www.crowe.com/services/consulting/microsoft-dynamics-365

Learn more about Crowe’s Microsoft Asset Leasing Quick Start Implementation here.