BLM11025 - Lease accounting: lease classification: residual values and guarantees

This manual is being updated to reflect FRS 102 (2024 amendments). For guidance on the tax treatment of accounts prepared under IFRS 16 or the revised FRS 102, please refer to pages within the BLM50000 chapter.

This section is applicable听to entities applying FRS 102 pre 2024 amendments or FRS 105, and for lessors only under IFRS 16 and FRS 102 (2024 amendments).听

See BLM17000听for lessee accounting under the on-balance sheet model under IFRS 16 and FRS 102 (2024 amendments).听

FRS 102听(pre 2024 amendments) and FRS 105听define听the residual value of an asset as 鈥�the听estimated amount that an entity would currently obtain from disposal of an asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life鈥�.听

Residual value guarantees are defined in FRS 102 (2024 amendments) and IFRS 16 as: 鈥淎 guarantee made to a lessor by a party unrelated to the lessor that the value (or part of the value) of an underlying asset at the end of a lease will be at least a specified amount.鈥�听

Operating lessors (and, rarely and to a smaller extent, finance lessors) may be exposed to the risk that the residual value is less than expected and so there is a market for guarantees which reduce that risk.听

The lessor may seek听to guarantee all or part of the residual value.听

Where part of the residual value is guaranteed,听it can be the top, bottom, or middle slice of that value. For example, if the residual value is expected to be 拢1,000,000 the lessor might take out a guarantee that will pay out if the value is less than 拢750,000 (thus restricting his exposure to 拢250,000).听

Alternatively, the lessor might insure听the top slice of 拢250,000, thus receiving compensation if the value falls to between 拢750,000 and 拢1,000,000, but no compensation for a fall in value below 拢750,000.听

The middle slice may be insured with, for example, payout being made if the value lies between 拢250,000 and 拢750,000.听

Where a guarantee is entered into at inception听it may make the lease a finance lease.听

A residual value guarantee entered into听some time after inception听would not normally affect the classification of the lease, but听see鈥�叠尝惭22070鈥�where the lease is a long funding lease.听

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