1. The lease must meet the definition of a direct financing lease (the 90% of fair value criterion does not apply).1
  2. The lease must involve at least three parties.
    1. An owner-lessor (equity participant)
    2. A lessee
    3. A long-term creditor (debt participant).
  3. The financing provided by the creditor is nonrecourse as to the general credit of the lessor and is sufficient to provide the lessor with substantial leverage.
  4. The lessor's net investment (defined below) decreases in the early years and increases in the later years until it is eliminated.

This last characteristic poses the accounting issue.

The leveraged lease arose as a result of an effort to maximize the income tax benefits associated with a lease transaction. To accomplish this, it was necessary to involve a third party to the lease transaction (in addition to the lessor and lessee): a long-term creditor. The following diagram2 illustrates the relationships in a leveraged lease agreement:

  1. The owner-lessor obtains long-term financing from the creditor, generally in excess of 50% of the purchase price. ASC 840 indicates that the lessor must be provided with sufficient leverage in the transaction, therefore the 50%.
  2. The owner then uses this financing along with his/her own funds to purchase the asset from the manufacturer.
  3. The manufacturer ...

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