Appendix C — Differences Between ASC 840 and ASC 842
Appendix C — Differences Between ASC 840 and ASC 842
The table below illustrates the key differences between ASC 842 and ASC 840.
Key Provision
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ASC 842
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ASC 840
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---|---|---|
Substantive substitution rights
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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
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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
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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.
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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:
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:
|
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
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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.
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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:
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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:
|
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:
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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.
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Footnotes
1
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.
2
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.