3.1 Introduction
As indicated in the decision tree in Section 2.2, whether a contract is within the
scope of ASC 842 is only a gating question. Once an entity determines that the
contract is within the scope, it must then proceed through the analysis in ASC
842-10-15 to determine whether the contract is or contains a lease.
Although a contract is not recognized and measured until commencement if it is a lease (see Chapters 8 and 9 for a detailed discussion of lessee and lessor accounting, respectively), the lease identification analysis must be performed at inception. If an arrangement is determined not to be, or not to contain, a lease, an entity must look to other U.S. GAAP (e.g., ASC 606) to determine the appropriate accounting and must apply the appropriate recognition and measurement guidance in such GAAP at whatever time is required, which could be at a contract’s inception.
Changing Lanes
Definition of a Lease Is the New Line
Between On- and Off-Balance-Sheet Treatments
Under ASC 842, the determination of whether an
arrangement is or contains a lease is critical. A lessee’s failure to
identify leases, including those embedded in service arrangements, is likely
to lead to a financial statement error given that ASC 842 requires lessees
to reflect all leases, other than short-term leases, on the balance sheet
(see Chapter 8
for further discussion of the lessee accounting model). On the other hand,
if a customer concludes that a contract is a service arrangement and does
not contain an embedded lease, the customer is not required to reflect the
contract on its balance sheet (unless it is required to do so by other U.S.
GAAP).
The assessment of the arrangement may be more critical under
ASC 842 than under ASC 840 because, under ASC 840, the balance sheet and
income statement treatment of operating leases was often the same as that of
service arrangements. In other words, under ASC 840, the difference between
on- and off-balance-sheet treatments often depended on whether the lease is
classified as operating or capital. Under ASC 842, however, all leases
(other than short-term leases) are on the balance sheet. Therefore, an
off-balance-sheet treatment will often depend on whether an arrangement
meets the definition of a lease.