Appendix C — Differences Between ASC 840 and ASC 842 | DART

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Appendix C — Differences Between ASC 840 and ASC 842

The table below illustrates the key differences between ASC 842 and ASC 840.

Key Provision	ASC 842	ASC 840
Substantive substitution rights	For a substitution right to be substantive and thus preclude lease accounting, the supplier must both (1) have the practical ability to substitute the asset and (2) economically benefit from the substitution. The concept of economically benefitting from the substitution is a new concept under ASC 842.	A lease does not exist if the supplier has the right and ability to substitute other PP&E to fulfill the arrangement. The supplier does not need to economically benefit from the substitution for lease accounting to be precluded (the substitution must be practicable and economically feasible).
Right to control the use of the asset	To control the use of the asset, the customer must have the right to (1) obtain substantially all of the economic benefits from using the asset and (2) direct the use of the asset (i.e., determine HAFWP the asset will be used throughout the period of use).	A customer does not need to both obtain substantially all of the economic benefits and direct the use of the asset to control the use of the asset. For example, the customer can control the use of the asset if (1) it obtains substantially all of the output or other utility generated by the asset and (2) the price it pays is neither contractually fixed per unit of output nor equal to the current market price of the output.
Separating land and other lease components	A lessee should account for land and buildings as separate lease components unless the accounting effect of doing so would be insignificant (e.g., there would be no impact on lease classification or the amount recognized for the land component would be insignificant).	When the lease meets either the transfer-of-ownership or bargain-purchase-price classification criteria, the lessee should account for the land and other assets separately. Otherwise, when the fair value of the land is 25 percent or more of the total fair value of the leased property at lease inception, the lessee should classify the land and other assets separately.
Separating lease and nonlease components	As a practical expedient,1 a lessee may elect not to separate lease and nonlease components in the contract. If this practical expedient is elected, the lessee must account for the combined components as a single lease component.	A similar practical expedient does not exist under ASC 840.
Maintenance	Maintenance services represent a nonlease component that must be separated from the lease component(s) in the contract (if the practical expedient described above is not elected).	Amounts paid by the lessee to the lessor for maintenance are generally considered executory costs.
Classification criteria	A lease should be classified as a finance lease if it meets one of the following criteria: Transfer of ownership. Bargain purchase option. Lease term is for a major part of the estimated economic life of the leased property. Present value of the lease payments is substantially all of the fair value of the leased property. The leased asset is so specialized that it would have no alternative use to the lessor at the end of the lease term. Although the lease classification criteria under ASC 842 differ from those under ASC 840, the FASB has stated that an entity may use the bright lines established under ASC 840 when evaluating the more principles-based criteria in ASC 842.	A lease should be classified as a capital lease if it meets one of the following criteria: Transfer of ownership. Bargain purchase option. Lease term is equal to 75 percent or more of the estimated economic life of the leased property. Present value of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property.
Executory costs	Executory costs (e.g., reimbursement for a lessor’s property taxes and insurance) are allocated to both lease and nonlease components in the contract on the same basis as the other consideration in the contract. The portion of executory costs allocated to the lease component(s) in the contract is considered part of the lease payments (to the extent that the payments are fixed).	All executory costs are excluded from the determination of minimum lease payments for classification and measurement purposes.
Residual value guarantees	A lessee should include in the lease payments only the amount of the residual value guarantee that it is probable the lessee will owe at the end of the lease term.	A lessee should include in the minimum lease payments the full amount of the residual value guaranteed by the lessee.
Discount rate	A lessee should use the rate implicit in the lease if it is readily determinable, regardless of whether it is higher than the lessee’s incremental borrowing rate. The rate implicit in the lease takes into account the lessor’s initial direct costs. The discount rate used must reflect a secured borrowing rate.	A lessee should use the rate implicit in the lease if it is readily determinable, unless that rate exceeds the lessee’s incremental borrowing rate. The rate implicit in the lease does not incorporate the lessor’s initial direct costs. The lessee’s incremental borrowing rate may be unsecured if it is consistent with the financing that would have been obtained to purchase the underlying asset (and not leased).
Inception date vs. commencement date	A lease is classified and initially measured on the lease commencement date.	A lease is classified and initially measured on the lease inception date.
Lessee accounting	All leases (finance and operating) other than those that qualify for the short-term scope exception must be recognized on the lessee’s balance sheet. A lessee recognizes a liability for its lease obligation and a corresponding asset representing its right to use the underlying asset over the lease term.	A lessee only recognizes capital leases on its balance sheet. Leases classified as operating leases are not capitalized on a lessee’s balance sheet.
Sales-type versus direct financing lease	The distinction between a sales-type lease and a direct financing lease is based on whether the lessee obtains control of the underlying asset. This assessment is not affected by the relationship of the fair value to the carrying amount of the underlying asset. If the lessee obtains control of the underlying asset, the lease is classified as a sales-type lease. If the lessee does not obtain control of the underlying asset (but the lessor relinquishes control), the lease is classified as a direct financing lease.	The distinction between a sales-type lease and a direct financing lease is based on whether there is a difference between the fair value and carrying amount of the underlying asset. If the fair value equals the carrying amount of the underlying asset, the lease is classified as a direct financing lease. Otherwise, the lease is classified as a sales-type lease.
Collectibility	Lessors should consider collectibility in accounting for their leases, and such consideration differs depending on whether the lease is classified as a sales-type, direct financing, or operating lease. A lease can still be classified as a sales-type lease if there are collectibility concerns. For a sales-type lease to be recognized, collectibility of the lease payments must be probable (in a manner consistent with ASC 606). The collectibility guidance for direct financing and operating leases is aligned with ASC 840 (i.e., if the lease is not a sales-type lease, the lease should be classified as an operating lease if collectibility of the lease payments and any residual value guarantee is not probable at lease commencement).	A lessor cannot recognize a capital lease unless collectibility of the minimum lease payments is reasonably predictable.
Lessor’s accounting for direct financing leases	A lessor must defer selling profit for a direct financing lease and recognize the deferred amount over the lease term.	Because a direct financing lease can only arise if the fair value equals the carrying amount of the underlying asset, no profit or loss arises under a direct financing lease.
Leases involving real estate	There is no unique guidance on classifying and accounting for leases involving real estate. Leases involving real estate are subject to the same general classification and measurement guidance as leases involving other PP&E.	Leases involving real estate are subject to specific guidance that is unique to real estate (e.g., the lessor will only classify a lease involving real estate as a sales-type lease if it meets the transfer-of-ownership criterion in ASC 840-10-25-1(a)).
Sale-and-leaseback arrangements	All assets are subject to the same sale-and-leaseback guidance (i.e., there is no unique guidance on sale-and-leaseback arrangements involving real estate). An entity should assess the criteria in ASC 606 to determine whether a sale has occurred. A repurchase option precludes sale accounting unless (1) the option is priced at the fair value of the asset on the date of exercise and (2) alternative assets exist that are substantially the same as the transferred asset and are readily available in the marketplace. The existence of a leaseback by itself would not indicate that a sale has not occurred unless the leaseback is classified as a finance lease.	There is specific guidance on sale-and-leaseback arrangements involving real estate (including integral equipment). A sale-and-leaseback arrangement involving nonintegral equipment that includes a repurchase option may not result in a failed sale if the option does not economically compel the seller-lessee to repurchase the equipment.
Leveraged lease accounting	ASC 842 does not include guidance on leveraged leases. Entities are not permitted to account for any new lease arrangements as leveraged leases after the effective date of ASC 842. Leveraged leases existing as of the effective date of ASC 842 would be subject to the guidance in ASC 842-50, which is generally consistent with the legacy accounting requirements for leveraged leases and effectively grandfathers in that guidance. If a leveraged lease is modified after the effective date of ASC 842, it would be accounted for as a new lease.	A lease is a leveraged lease if it meets all of the following characteristics: It meets the criteria to be classified as a direct financing lease. It involves at least three parties, including a long-term creditor. The financing provided by the creditor is nonrecourse with respect to the lessor’s general credit. The lessor’s net investment declines during the early years and rises during the later years.
Build-to-suit lease arrangements	ASC 842 supersedes the guidance in ASC 840 on build-to-suit arrangements. Under ASC 842, the accounting for a build-to-suit arrangement depends on whether the lessee controls the underlying asset during the construction period.	A lessee is considered the owner of an asset during the construction period if the lessee has substantially all of the construction period risks. There are certain automatic indicators of ownership, which have historically caused a number of lessees to be deemed owners of assets during the construction period.
Related-party leases	Entities should account for related-party leasing arrangements on the basis of the legally enforceable terms and conditions of the lease rather than the substance of the arrangement. Common-Control Arrangements ASU 2023-01 allows private companies, as well as not-for-profit entities that are not conduit bond obligors, to elect a practical expedient in which the written terms and conditions of the arrangement are used to determine whether a lease exists and the subsequent accounting for the lease.	Entities should account for related-party leasing arrangements on the basis of the substance of the contract.
Reassessment (identifying a lease)	An entity should only reassess whether the contract is or contains a lease if the terms and conditions of the contract are changed.	An entity should only reassess whether an arrangement is or contains a lease if any of the following occur: Change in contractual terms. Renewal or extension (excluding a modification). Dependency on specific PP&E. Physical change to PP&E.
Reassessment (lessee measurement)	Upon a reassessment event, a lessee should remeasure its ROU asset and lease liability on its balance sheet. A lessee should use the discount rate that applies as of the date of the reassessment event to remeasure its ROU asset and lease liability.	A lessee should not remeasure a capital lease liability during the lease term unless the lease is modified. If the lease is modified and remeasured, the remeasurement should be based on the discount rate that was used at lease inception (i.e., the discount rate should not be updated).
Lease modifications	The lease modification guidance is more extensive under ASC 842, and the two-step model from ASC 840 is not carried forward. The changes are primarily related to aligning the modification guidance with the guidance in ASC 606.	A modification of a lease should be accounted for as a new lease if the modification would have resulted in a different lease classification had the changed terms been in effect at lease inception. A lease modification does not include renewals or extensions of the lease if such renewals or extensions were already included in the lease term.
Initial direct costs	Initial direct costs include only those costs that are incremental to the arrangement and that would not have been incurred if the lease had not been obtained.	In addition to costs that are incremental to the arrangement and that would not have been incurred if the lease had not been obtained, initial direct costs include costs directly related to the following activities: Evaluating the prospective lessee’s financial condition. Evaluating and recording guarantees, collateral, and other security arrangements. Negotiating lease terms. Preparing and processing lease documents. Closing the transaction.
Impairments	Operating leases are subject to the impairment guidance in ASC 360.	Operating leases are subject to the guidance in ASC 420 on exit and disposal activities.
Statement of cash flows (lessor)	A lessor must classify cash received from leases in the operating activities section of its statement of cash flows.2	ASC 840 does not include guidance on the classification of cash received from leases in a lessor’s statement of cash flows.
Disclosures	An entity must disclose significantly more quantitative and qualitative information under ASC 842.	Lessees and lessors are subject to relatively limited disclosure requirements.

Footnotes

In July 2018, the FASB issued ASU 2018-11, which includes a practical expedient that allows lessors, when certain conditions are met, not to separate lease and nonlease components. Under ASU 2018-11, lessors availing themselves of this practical expedient would not account for affected nonlease components separately. See Section 17.3.1.4.2 for further discussion.

In March 2019, the FASB issued ASU 2019-01, which amended the presentation of the statement of cash flows for entities within the scope of ASC 942. Such entities are required to classify principal payments received from sales-type and direct financing leases in the investing activities section of their statement of cash flows. This requirement is associated with an illustrative example in ASC 942 that existed before the adoption of, and was not amended by, ASC 842.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.