4 Recognizing assets acquired, liabilities assumed and any noncontrolling interest
Financial reporting developments Business combinations | 155
4.4.4.3.1 Lessee accounting
Operating leases — Acquired operating leases should be assessed to determine if the lease terms are favorable
or unfavorable given market conditions on the acquisition date. To the extent the lease arrangement is
favorable or unfavorable relative to market on the acquisition date or has an inherent value, an asset or
liability, respectively, is recognized at fair value in the business combination. The estimate of fair value
considers all provisions of the lease (term, purchase options, renewal options, termination penalties, residual
value guarantees, etc.) from the perspective of a market participant. An acquirer would not recognize any
deferred rent previously recognized by the acquired entity because the lease is recognized at its acquisition-
date fair value and the acquiree’s deferred rent does not meet the definition of an asset or liability at the
acquisition date. Generally, the recognized asset or liability is amortized to rental expense over the remaining
term of the lease to reflect a market rental cost per period based on market conditions at the acquisition date
(absent provisions that could result in fluctuating rent expense — e.g., contingent rent provisions). However, if
a portion of the fair value relates to a lease purchase option, we believe the fair value attributed to the lease
purchase option, provided it is likely to be exercised, would not be amortized over the term of the lease, but
rather would affect the recognized value of the asset upon exercise of the purchase option. For example, if the
acquired purchase option on the leased asset is in-the-money on the acquisition date, the accounting basis of
the subject asset upon exercise of the purchase option would be the sum of the exercise price plus the fair
value of the acquired purchase option on the acquisition date. Additionally, if a portion of the fair value relates
to a renewal option that was not included in the original lease term, provided it is determined that it is likely
the option will be exercised (e.g., because of favorable market conditions), the value attributed to the renewal
would not be amortized over the term of the lease, but rather would be amortized over the renewal period.
Furthermore, the fair value of any leasehold improvements would be recognized the same as other plant and
equipment assets acquired. See section 4.2.4 for further discussion of accounting for plant and equipment
assets acquired in a business combination.
Capital leases — Assets under capital leases and capital lease obligations of acquired companies that are
lessees are recognized at fair value as of the acquisition date in a business combination. The fair value of
a capital lease obligation is measured similar to assumed debt. Similarly, the fair value of assets acquired
under capital leases is measured and recognized based on the concepts discussed for measuring and
recognizing assets acquired, as described in section 4.2.4. In general, a separate intangible asset or
liability would not be recognized for the fair value of the lease contract. That is, any value in the lease
(e.g., favorable or unfavorable lease terms relative to market or the in-place lease value) would be
reflected in the measurement of the assets under capital lease and the capital lease obligation.
4.4.4.3.1.1 Measurement of property under capital lease
In measuring the amount to recognize for an acquired asset under a capital lease, the acquirer should
consider why the lease was originally classified as a capital lease. That is, if the acquired lease was
capitalized by the acquiree because the lease met one of the first two criteria set forth in ASC 840-10-25-1
(i.e., (a) title transfers to the acquiree or (b) the lease contains a bargain purchase option at the end of the
lease term), the asset is recognized and measured by the acquirer at its acquisition-date fair value of the
underlying asset. If it is not anticipated that the acquirer will obtain ownership of the leased asset (meaning
the acquired leased asset was capitalized because (c) the lease term is equal to 75% or more of the
estimated economic life of the leased property or (d) the present value of the minimum lease payments
equals or exceeds 90% of the fair value of the leased property) or the acquirer does not intend to exercise
any in-place bargain purchase option, the asset underlying the lease would be recognized and measured
by the acquirer at the fair value of the leasehold interest (i.e., the value of the right to use the property
for the remaining lease term and other rights under the lease). Any related leasehold improvements of
the acquired entity would be recognized as tangible assets on the acquisition date at their fair value.