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Residual value guarantee for a lessee
Residual value guarantee for a lessee

How residual value guarantees are defined by the lease accounting standards (ASC 842/ IFRS 16) and how they are treated in Cradle.

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Written by Support
Updated over a week ago

Here we will describe how the standard details how to account for a residual value guarantee and how Cradle treats them.

What is a residual value guarantee?

A residual value guarantee provides a lessor with certainty (subject to credit risk) that the fair value of the underlying asset subject to lease will not decline below a certain amount. Lessees may be motivated to provide such guarantees in order to obtain a lease that may not otherwise be available to them or to obtain more favorable pricing for the leased asset. Lessors may also secure residual value guarantees from a third party to reduce or eliminate their risk in the residual value of the asset.

ASC 842

As per ASC 842 842-10-30-5:

At the commencement date, the lease payments shall consist of the following payments relating to the use of the underlying asset during the lease term:

  1. Fixed payments, including in-substance fixed payments, less any lease incentives paid or payable to the lessee (see paragraphs 842-10-55-30 through 55-31).

  2. Variable lease payments that depend on an index or a rate (such as the Consumer Price Index or a market interest rate), initially measured using the index or rate at the commencement date.

  3. The exercise price of an option to purchase the underlying asset if the lessee is reasonably certain to exercise that option (assessed considering the factors in paragraph 842-10-55-26).

  4. Payments for penalties for terminating the lease if the lease term (as determined in accordance with paragraph 842-10-30-1) reflects the lessee exercising an option to terminate the lease.

  5. Fees paid by the lessee to the owners of a special-purpose entity for structuring the transaction. However, such fees shall not be included in the fair value of the underlying asset for purposes of applying paragraph 842-10-25-2(d).

  6. For a lessee only, amounts probable of being owed by the lessee under residual value guarantees (see paragraphs 842-10-55-34 through 55- 36).

Definition from ASC 842 Glossary

Residual Value Guarantee: A guarantee made to a lessor that the value of an underlying asset returned to the lessor at the end of a lease will be at least a specified amount.

Cradle's Treatment

The residual value guarantee is a lease payment that will occur on the last day of the lease. This payment is present valued to make up the lease liability.

IFRS 16

As per AASB 16 paragraph 27

At the commencement date, the lease payments included in the measurement of the lease liability comprise the following payments for the right to use the underlying asset during the lease term that are not paid at the commencement date:

(a) fixed payments (including in-substance fixed payments as described in paragraph B42), less any lease incentives receivable;

(b) variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date (as described in paragraph 28);

(c) amounts expected to be payable by the lessee under residual value guarantees;

(d) the exercise price of a purchase option if the lessee is reasonably certain to exercise that option (assessed considering the factors described in paragraphs B37–B40); and

(e) payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease

Cradle's Treatment

The residual value guarantee is a lease payment that will occur on the last day of the lease. This amount is present valued to make up the lease liability.

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