Defining long funding leases: miscellaneous definitions: term of a lease: 'reasonably certain': example 1 - extending term is expensive
H Ltd leases machines that cost £4,000 each. Lease rentals are £1,000 a year. Minimum lease period is 5 years. At the 5-year point, each lessee can either
- walk away without further payment, whether by not exercising an option to extend the lease term or exercising an option to terminate it, or
- carry on renting the machine for £1000 a year.
In most cases it would not be reasonably certain that the lessees would exercise their option to extend the lease term because they would, in effect, be paying a high price to do so (the same rental as was charged for the asset when new, even though it has, in effect, been paid for).
If, for example, H Ltd knew from experience that on average 10% extend beyond 5 years (but it is not known which 10%) then none of the leases are reasonably certain to extend beyond 5 years.
However, if H Ltd knows that the great majority of lessees exercise an option to extend the lease term then it is reasonably certain that the options will be exercised - see example 2.