1.3 Key Provisions

Scope

(Chapter 2)

The scope of ASC 842 includes leases of all property, plant, and equipment (PP&E) and excludes:

• Leases of intangible assets.
• Leases to explore for or use nonregenerative resources.
• Leases of biological assets.
• Leases of inventory.
• Leases of assets under construction.

Identifying a lease

(Chapter 3)

A lease is defined as a “contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.“

• A leased asset must be specifically identifiable either explicitly (e.g., by a serial number) or implicitly (e.g., the only asset available to satisfy the lease contract).

  • Substantive substitution rights will need to be considered.
  • A physically distinct portion of a larger asset could represent a specified asset (e.g., one floor of a building).
  • A capacity portion of a larger asset will generally not represent a specified asset (e.g., 50 percent of a storage tank).
• A contract conveys the right to control the use of the identified asset when the customer has both of the following:

  • The right to obtain substantially all of the economic benefits from its use.
  • The right to direct its use.

Components of a contract

(Chapter 4)

An entity is generally required to identify the lease and nonlease components of a contract that contains a lease. A contract may also contain multiple lease components. The right to use an underlying asset is considered a separate lease component if (1) a lessee can benefit from the use of the underlying asset either on its own or together with other resources that are readily available and (2) the underlying asset is not highly dependent on or highly interrelated with other assets in the arrangement.

When a contract includes multiple components, an entity is generally required to allocate the consideration in the contract to the various components. The guidance for lessors on allocating the consideration in the contract is separate from that for lessees.

Lease term

(Chapter 5)

The lease term is the noncancelable period in which the lessee has the right to use an underlying asset together with optional periods (1) for which it is reasonably certain that the lessee will exercise the renewal option or not exercise the termination option or (2) covered by an option to extend (or not to terminate) the lease in which the exercise of the option is controlled by the lessor. Lessees will be required to reassess the lease term after lease commencement in certain circumstances; however, lessors are not required to reassess the lease term unless the lease is modified and the modified lease is not a separate contract.

Lease payments

(Chapter 6)

Lease payments include:

• Fixed payments (including in-substance fixed lease payments).
• Variable payments that are based on an index or rate, calculated by using the index or rate that exists on the lease commencement date (i.e., the spot rate).
• For lessees, amounts that it is probable will be owed under residual value guarantees. For lessors, amounts at which residual assets are guaranteed by a lessee or by a third party.
• Payments related to purchase or termination options when the lessee is reasonably certain to exercise the option or is not reasonably certain not to exercise, respectively.

Lease payments do not include variable lease payments that are based on the usage or performance of the underlying asset (e.g., a percentage of revenues).

Discount rate

(Chapter 7)

Lessees use the rate charged by the lessor (i.e., the rate implicit in the lease) if that rate is readily determinable. If that rate is not readily determinable, lessees will use their incremental borrowing rate as of the date of lease commencement.

Lessors use the rate they charge the lessee.

Private-company lessees can elect to use a risk-free rate.

Lessee accounting

(Chapter 8)

As of the lease commencement date, a lessee recognizes:

• A liability for its lease obligation (initially measured at the present value of lease payments not yet paid).
• An asset for its right to use the underlying asset (i.e., the ROU asset, initially measured equal to the lease liability and adjusted for lease payments made at or before lease commencement, lease incentives, and any initial direct costs).

The lessee will use the effective interest rate method to subsequently account for the lease liability.

Two approaches are used for subsequently amortizing the ROU asset: (1) the finance lease approach and (2) the operating lease approach. Under the finance lease approach, the ROU asset is generally amortized on a straight-line basis. This amortization, when combined with the interest on the lease liability, results in a front-loaded expense profile in which interest and amortization are presented separately in the income statement. By contrast, the operating lease approach generally results in a straight-line expense profile that is presented as a single line item in the income statement.

The determination of which approach to apply is based on lease classification criteria that are similar to the requirements in IAS 17.

Lessor accounting

(Chapter 9)

The lessor accounting model retains the approach for operating and capital/ finance (direct financing and sales-type) leases.

However, the lease classification criteria will change, and the treatment of selling profit, if any, will be affected:

• Selling profit would be recognized up front if the arrangement is a sales-type lease (i.e., if the transaction qualifies as a sale under ASC 606).
• Selling profit resulting from a direct financing lease, if any, would be deferred and recognized as interest income over the lease term.

Leveraged lease accounting is eliminated going forward (i.e., existing leveraged leases are grandfathered).

Lease modifications

(Chapters 8 and 9)

A lease modification is any change to the contractual terms and conditions of a lease that results in a change in the scope of or the consideration for a lease.

• A lessee/lessor would account for a lease modification as a separate contract (i.e., separate from the original lease) when the modification (1) grants the lessee an additional ROU asset and (2) the price of the additional ROU asset is commensurate with its stand-alone price.
• Lessees would account for a lease modification that is not a separate contract by using the discount rate as of the modification effective date to adjust the lease liability and ROU asset for the change in the lease payments. The modification may result in a gain or loss if the modification results in a full or partial termination of an existing lease.
• Lessors would account for a lease modification in a manner generally consistent with the modification guidance in ASC 606.

Sale-and-leaseback transactions

(Chapter 10)

A transaction is accounted for as a sale-and-leaseback transaction when control of the underlying asset is transferred from the seller-lessee to the buyer-lessor in accordance with ASC 606. In addition to the control transfer principle in ASC 606, the transfer of the underlying asset is not considered a sale if either of the following conditions is met:

• The leaseback is a finance lease.
• There is a repurchase option, unless (1) the exercise price of the option is at fair value and (2) alternative assets are readily available in the marketplace.

If control of the underlying asset is transferred to the buyer-lessor, the transaction is accounted for as a sale and leaseback and the entire gain on the transaction would be immediately recognized.