HQ Office - 500 Michigan Ave, Chicago
Lease ID: L-2022-001 • Entity: Midwest Manufacturing Co.
A lease is classified as a finance lease if it meets ANY of the following 5 criteria. Otherwise, it is an operating lease.
1. Transfer of Ownership
Does the lease transfer ownership of the underlying asset to the lessee by the end of the lease term?
2. Purchase Option
Does the lease grant the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise?
3. Lease Term ≥ Major Part of Economic Life
Is the lease term for a major part (≥75%) of the remaining economic life of the underlying asset?
4. Present Value ≥ Substantially All of Fair Value
Is the present value of lease payments ≥ substantially all (≥90%) of the fair value of the underlying asset?
5. Specialized Nature
Is the underlying asset of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term?
Under ASC 842, lessees must separate lease components from non-lease components unless they elect the practical expedient to combine them.
When elected, all components are accounted for as a single lease component.
Component Breakdown
| Component | Type | Annual Amount | Allocation % | Treatment |
|---|---|---|---|---|
| Base Rent | Lease | $294,000 | 75.4% | Capitalize (ROU Asset) |
| Common Area Maintenance (CAM) | Non-Lease | $48,000 | 12.3% | Combined with lease* |
| Property Taxes | Non-Lease | $31,200 | 8.0% | Combined with lease* |
| Insurance | Non-Lease | $16,800 | 4.3% | Combined with lease* |
| Total | $390,000 | 100% |
* Practical expedient elected - non-lease components combined with lease component and capitalized.
Impact on Lease Liability
🎯 Discount Rate Determination
Rate that causes PV of lease payments + unguaranteed residual = Fair value of asset + Initial direct costs of lessor
Rate the lessee would pay to borrow on a collateralized basis over a similar term
IBR Documentation (Required for Audit)
| Base rate (5-year Treasury) | 4.25% |
| Credit spread adjustment | +0.75% |
| Collateral adjustment | -0.25% |
| Lease term adjustment | +0.50% |
| Final IBR | 5.25% |
Rate determined as of lease commencement date (August 1, 2022) based on company's credit profile and collateral characteristics.
📊 Initial Measurement (Commencement Date: Aug 1, 2022)
Lease Liability
| Present value of lease payments | $1,284,500 |
| Initial Lease Liability | $1,284,500 |
ROU Asset
| Initial lease liability | $1,284,500 |
| + Initial direct costs | $12,500 |
| + Prepaid lease payments | $0 |
| - Lease incentives received | ($50,000) |
| Initial ROU Asset | $1,247,000 |
📈 Subsequent Measurement (Current: Jan 31, 2025)
Lease Liability
| Beginning balance | $1,109,975 |
| + Interest accretion | $4,765 |
| - Lease payments | ($24,500) |
| Ending Lease Liability | $1,089,240 |
ROU Asset
| Beginning balance | $1,176,180 |
| - Amortization expense | ($19,760) |
| - Impairment | $0 |
| Ending ROU Asset | $1,156,420 |
A lease modification is a change to the terms and conditions of a contract that results in a change in scope or consideration.
Modification History
Added 5,000 sq ft on Floor 5 (Suite 502). Not a separate lease - price not commensurate with standalone price.
Accounting Treatment
Not a separate lease - Modification does not grant additional right-of-use at standalone price.
- Remeasured lease liability using revised discount rate (5.50%)
- Adjusted ROU asset by same amount as liability change
- No gain/loss recognized
| Lease liability adjustment | +$186,420 |
| ROU asset adjustment | +$186,420 |
| New monthly payment | $24,500 → $29,500 |
Considering exercising early termination option (available after Year 4). Would result in partial termination accounting.
Modification Decision Tree
ROU assets are subject to impairment testing under ASC 360. Test when triggering events indicate carrying amount may not be recoverable.
Impairment Indicators Checklist
Impairment Test History
| Date | Trigger | Carrying Amount | Fair Value | Impairment | Result |
|---|---|---|---|---|---|
| Dec 31, 2024 | Annual review | $1,196,180 | $1,350,000 | $0 | No Impairment |
| Dec 31, 2023 | Annual review | $1,284,500 | $1,420,000 | $0 | No Impairment |
As an intermediate lessor, subleases are classified by reference to the ROU asset arising from the head lease, not the underlying asset.
Sublease: Suite 401 to TechStartup Inc.
Operating SubleaseSublease Terms
| Sublessee: | TechStartup Inc. |
| Space: | Suite 401 (5,000 sq ft) |
| Term: | Jan 1, 2024 - Jul 31, 2028 |
| Monthly Rent: | $8,500 |
| Annual Escalation: | 2.5% |
Accounting Treatment
Classification: Operating sublease (does not meet any finance lease criteria relative to ROU asset)
Income recognition: Straight-line over sublease term
| Monthly sublease income | $8,500 |
| Allocated head lease cost | ($4,900) |
| Net sublease margin | $3,600/mo |
Monthly Journal Entry (Sublease)
| Cash | $8,500 | |
| Sublease Income | $8,500 |
Head Lease vs Sublease Summary
| Head Lease | Sublease | Net Position | |
|---|---|---|---|
| Total Space | 25,000 sq ft | 5,000 sq ft | 20,000 sq ft (used) |
| Monthly Cost/Income | ($24,500) | $8,500 | ($16,000) net cost |
| Remaining Term | 42 months | 42 months | Co-terminus |
Maturity Analysis - Lease Liability
Undiscounted cash flows by fiscal year (ASC 842-20-50-4)
| Year | Operating Leases |
|---|---|
| 2025 (remaining) | $269,500 |
| 2026 | $302,940 |
| 2027 | $312,028 |
| 2028 | $227,200 |
| 2029 | $0 |
| Thereafter | $0 |
| Total undiscounted | $1,111,668 |
| Less: Imputed interest | ($22,428) |
| Total Lease Liability | $1,089,240 |
Weighted Average Calculations
| Weighted average remaining lease term - Operating | 3.5 years |
| Weighted average discount rate - Operating | 5.25% |
Lease Cost (ASC 842-20-50-4b)
| Component | YTD 2025 | FY 2024 |
|---|---|---|
| Operating lease cost | $23,760 | $285,120 |
| Short-term lease cost | $0 | $12,400 |
| Variable lease cost | $4,200 | $48,600 |
| Sublease income | ($8,500) | ($102,000) |
| Net lease cost | $19,460 | $244,120 |
| Account | Account # | Debit | Credit |
|---|---|---|---|
| Lease Liability - Operating (Current) | 2100 | $19,735 | |
| Interest Expense - Lease | 7200 | $4,765 | |
| Cash | 1000 | $24,500 | |
| Total | $24,500 | $24,500 | |
| Account | Account # | Debit | Credit |
|---|---|---|---|
| Lease Expense - Operating | 6100 | $23,760 | |
| ROU Asset - Operating | 1800 | $19,760 | |
| Lease Liability - Operating | 2100 | $4,000 | |
| Total | $23,760 | $23,760 | |
Note: For operating leases, single lease cost is recognized on straight-line basis. The ROU asset amortization is adjusted to achieve straight-line expense.
Lease Approved by CPA
Last reviewed and approved on January 15, 2025 by Sarah Chen, CPA
Review History
Q4 2024 review complete. Classification and calculations verified. Disclosures approved for annual report.
Initial lease setup approved. IBR documentation adequate. Classification as operating lease confirmed.
Modification for expansion recorded correctly. Verified remeasurement calculation using revised rate.