How to Properly Identify a Lease and Asset Under New ASC 842 Standard
The new Lease Accounting Standard (“ASC 842”) will have a significant impact on how businesses manage, account for and report substantially all leases, including equipment and real estate. Because of the meaningful accounting changes involved, it’s important businesses begin preparing now to comply with the new standards.
ASC 842 requires businesses to recognize most leases on their balance sheet—essentially all contracts that meet the definition of a lease, including operating leases, will be recognized on balance sheets via a right-of-use (ROU) asset and lease liability.
How Is a Lease Defined and Identified?
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.
|Right to Control||
To determine if a right to control exists, the following two factors must be considered:
- Analysis of "Right to substantially all economic benefits from the use of the identified asset": Right to obtain substantially all of the economic benefits from use of an asset, an entity shall consider the economic benefits that result from use of the asset within the defined scope of a customer’s right to use the asset in the contract.
- Analysis of "Right to Direct the Use of the Identified Asset": A customer has the right to direct how and for what purpose an asset is used throughout the period of use if, within the scope of its right of use defined in the contract, it can change how and for what purpose the asset is used throughout that period.
To determine if an identified asset exists, the following three factors must be considered:
- Analysis of “Explicitly or Implicitly Identified Asset” - If a contract explicitly identifies the asset to be used but contains contractual terms that allow the supplier to fulfill the contract without the use of the identified asset specified, the contract does not meet the requirement for use of an explicitly identified asset. Conversely, when only one asset can be used to fulfill the contract then the asset is considered implicitly identified. The key consideration is whether the substitution right is substantive based on the facts and circumstances at inception of the contract.
- Analysis of “Asset is Physically Distinct” - An identified asset must be physically distinct. A physically distinct asset may be an entire asset or a portion of an asset. For example: A contract for a portion of the capacity in a pipeline to transport natural gas is not physically distinct because it cannot be distinguished from other concurrent users of the pipeline. However, if the customer contracts to use “substantially all "capacity, or a specified segment of the pipeline, then it may be considered physically distinct.
- Analysis of “Supplier Does Not Have a Substantive Right of Substitution” – If you answer yes to both questions, a substantive substitution right exists. The supplier has the practical ability to substitute alternative assets throughout the period of use. The supplier would benefit economically from the exercise of its right to substitute the asset.
Dacarba LLC can offer technical accounting guidance and lead technology implementation projects by leveraging our ASC 842 experience and lessons learned such as the importance of a clearly documented approach to adoption, proving completeness of the lease population and locating unidentified leases. Dacarba also facilitates roundtables with industry peers to discuss common issues and call upon our experience to act as a client-advocate in situations where audit firms are reaching inconsistent answers with industry peers.
Dacarba's Complex Financial Reporting practice includes members who have served lead roles on Fortune 250 ASC 842 cross-functional teams. Dacarba’s Process and Technology staff have coordinated, led and assisted large-scale lease accounting software implementation projects, as well as built customizable small-scale solutions for clients with fewer leases.
To learn more how we can help with your lease accounting preparation and compliance needs, email us at Leasing842@dacarba.com and we will initiate the introduction to our team to assess your requirements.