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 to entities applying FRS 102 pre 2024 amendments or FRS 105, and for lessors only under IFRS 16 and FRS 102 (2024 amendments).
See BLM17000 for lessee accounting under the on-balance sheet model under IFRS 16 and FRS 102 (2024 amendments).
FRS 102 (pre 2024 amendments) and FRS 105 define the residual value of an asset as “the 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”.
Residual value guarantees are defined in FRS 102 (2024 amendments) and IFRS 16 as: “A 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.”
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.
The lessor may seek to guarantee all or part of the residual value.
Where part of the residual value is guaranteed, it can be the top, bottom, or middle slice of that value. For example, if the residual value is expected to be £1,000,000 the lessor might take out a guarantee that will pay out if the value is less than £750,000 (thus restricting his exposure to £250,000).
Alternatively, the lessor might insure the top slice of £250,000, thus receiving compensation if the value falls to between £750,000 and £1,000,000, but no compensation for a fall in value below £750,000.
The middle slice may be insured with, for example, payout being made if the value lies between £250,000 and £750,000.
Where a guarantee is entered into at inception it may make the lease a finance lease.
A residual value guarantee entered into some time after inception would not normally affect the classification of the lease, but see BLM22070 where the lease is a long funding lease.