Unguaranteed Residual Value

Definition

The financial accounting term unguaranteed residual value refers to the worth of a lease property at the end of the agreement's term that is not the responsibility of the lessee.  Unguaranteed residual values do not qualify as a financial obligation of the lessee, and do not factor into the calculation of the minimum lease payment.

Explanation

Generally, a residual value is an estimate of the fair market value of the leased property at the end of the agreement's term.  As part of the lease, the lessee may provide a guaranteed residual value.  If so, this becomes a financial obligation of the lessee, and can result in an additional cash payment to the lessor when the agreement terminates.

Alternatively, the agreement may state the residual value is unguaranteed.  The projected fair market value of the leased property is still used in the determination of the monthly lease payment; however, the risk associated with the accuracy of this estimate remains with the lessor.  Since the lessee is not responsible for guaranteeing a residual value payment at the end of the lease, they bear no financial obligation to the lessor.  This is why an unguaranteed residual value is excluded from the calculation of a minimum lease payment.

Since the terms and conditions of lease contracts will vary, the Financial Accounting Standards Board issued FAS No. 13 - Accounting for Leases, which outlines the criteria used to determine if the agreement should be treated as a capital versus operating lease.  The concept of a minimum lease payment is an important variable used in the recovery of investment test (90% test), which is used to determine if an agreement should be treated as an operating or capital lease.

Related Terms

operating lease, capital lease, bargain-purchase option test, transfer of ownership test, economic life test, recovery of investment test, economic life, economic life test, economic life, executory costs, minimum lease payment, guaranteed residual value