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1.2 High-level overview
Publication date: 31 May 2023
us Leases guide
The FASB concluded that a lessee’s obligation to make lease payments meets the definition of a liability because it involves a present obligation that arises from a past event and the obligation is expected to result in an outflow of economic benefits. The “past event” arises when the lessee signs the lease and the lessor makes the underlying leased asset available to the lessee. The “present obligation” arises because the lessee cannot typically avoid making the contractual payments.
The boards also believe that a lessee’s right to use the underlying asset during the lease term meets the definition of an asset. Despite legally owning the asset, the lessor typically cannot use the underlying asset or even access the underlying asset without the lessee’s consent.
These two conclusions form the core principles of ASC 842.
Excerpt from the Summary of ASU 2016-02
The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases.
1.2.1 Definition and scope
A lease conveys the right to use an underlying asset for a period of time in exchange for consideration. At the inception of an arrangement, the parties should determine whether the contract is or contains a lease by assessing both of the following:
● Whether there is an identified asset
● Whether the contract conveys the right to control the use of the identified asset in exchange for consideration for a period of time
Often, it may be easy to determine that an arrangement contains a lease. Other times, it may be difficult to distinguish between a lease and an arrangement to buy or sell goods or services. See LG 2 for information on evaluating whether an arrangement is a lease or contains a lease.
The leases standard does not require lessees to reflect lease assets and liabilities on the balance sheet for arrangements with a lease term of 12 months or less. See LG 2.2.1 for additional information on this short-term lease measurement and recognition exemption. In addition, certain arrangements are outside the scope of the leases standard, including:
● Leases of inventory or of construction in progress
● Leases of intangible assets, including licenses of internal-use software
● Leases to explore for or use natural resources
● Leases of biological assets
● Service concession arrangements within the scope of ASC 853, Service Concession Arrangements
As discussed in LG 7, ASC 842 does not recognize a leveraged lease. However, lessors should continue to account for leveraged leases existing at the application date of the leases standard using the guidance in ASC 840, Leases, provided such leases are not modified on or after the application date of ASC 842.
1.2.2 Lessee classification
Under ASC 842, leases are subject to a dual accounting model, under which different types of leases have different accounting treatment subsequent to the initial recognition of lease assets and liabilities. The principal distinction between the two types of leases is in the resulting income statement recognition. As discussed in LG 4, a lessee with a finance lease is required to apply a financing model in which the expense resulting from the lease declines during the lease term. Operating leases, on the other hand, result in lease expense typically recognized on a straight-line basis, by amortizing the leased asset more slowly than a finance leased asset.
1.2.3 Lessor classification
Lessors are also required to classify leases. Sales-type and direct financing leases are recognized by a lessor as lease receivables, with interest income that is typically front-loaded (i.e., income per period declines during the lease term). The distinction between a sales-type and a direct financing lease is that in a sales-type lease, the lessee obtains control of the underlying asset and the lessor recognizes selling profit and sales revenue upon lease commencement. In order to align lessor accounting with the principles in the revenue recognition guidance in ASC 606, a lessor is precluded from recognizing selling profit or sales revenue at lease commencement for a lease that does not transfer control of the underlying asset to the lessee.
An operating lease results in the recognition of lease income on a straight-line basis, while the underlying leased asset remains on the lessor’s balance sheet and continues to depreciate.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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