Expand
Resize
Add to favorites
In a lease, one party obtains the right to use an asset legally owned by another party for a period of time. It is this right of use that distinguishes a lease from other executory contracts. The rights of a lessee are different from those of an owner of an asset or a party to a service agreement that does not transfer a right of use. Nonetheless, a lessee does have certain rights that receive accounting recognition as an asset (with a corresponding liability for the obligation to make payments for that right of use) because a lessee has control over an economic resource and is benefiting from the use of the asset.
ASC 842-10-15-3 defines a lease as follows.

ASC 842-10-15-3

A contract is or contains a lease if the contract 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 period of time may be described in terms of the amount of use of an identified asset (for example, the number of production units that an item of equipment will be used to produce).

A lease conveys the right to use an identified asset for a period of time. Arrangements that are truly perpetual in nature would not meet the definition of a lease because there is no defined period of use. These arrangements are more akin to acquiring an asset, and therefore, would be outside the scope of ASC 842.
Reporting entities may need to consider if certain arrangements are truly perpetual in nature. “Pay as you go” arrangements may provide the right to use an asset indefinitely. However, if the arrangement can be terminated by the customer at any time by merely stopping payment, the perpetual provision may not be substantive, and entities would need to evaluate the lease term. See LG 3.3.3.1 for information on determining the term of a lease.
The right to control the use of an asset may not necessarily be documented, in form, as a lease agreement. Often, the right to use an identified asset is embedded in an arrangement that may appear to be a supply arrangement or service contract. Therefore, a reporting entity should consider all of the terms of an arrangement to determine whether it contains a lease.
When performing the analysis to determine if an arrangement contains an embedded lease, multiple arrangements may be considered to be a single transaction. If two or more arrangements are entered into at the same time, a reporting entity should consider whether the analysis should be performed on each contract or the combination of contracts. ASC 842-10-25-19 specifies the criteria to consider in making this determination.

ASC 842-10-25-19

An entity shall combine two or more contracts, at least one of which is or contains a lease, entered into at or near the same time with the same counterparty (or related parties) and consider the contracts as a single transaction if any of the following criteria are met:

  1. The contracts are negotiated as a package with the same commercial objective(s).
  2. The amount of consideration to be paid in one contract depends on the price or performance of the other contract.
  3. The rights to use underlying assets conveyed in the contracts (or some of the rights of use conveyed in the contracts) are a single lease component in accordance with paragraph 842-10-15-28.

If a combination of contracts is determined to contain a lease, the same combined transaction should be used for purposes of lease classification, recognition and measurement in accordance with the guidance in ASC 842.
See LG 2.6 for discussion on when to perform the determination as to whether an arrangement is a lease.

2.3.1 Use of an identified asset

To meet the definition of a lease, an arrangement must require use of an explicitly or implicitly identified asset that is physically distinct. Figure LG 2-1 highlights key considerations in determining whether there is an identified asset. Each consideration is discussed further in the sections that follow.
Figure LG 2-1
Determining whether there is an identified asset
Figure 2-1 Determining whether there is an identified asset

2.3.1.1 Explicitly specified asset

If a contract explicitly specifies the asset to be used (e.g., by serial number or a specified floor of a building), the contract contains an identified asset unless the supplier has substantive substitution rights. See LG 2.3.1.4 for discussion of substitution rights.

2.3.1.2 Implicitly specified asset

A contract that does not explicitly specify an asset to be used to fulfill the contract may implicitly specify the asset, for example, when the asset is made available for use. When a supplier must use an asset (i.e., plant, property and equipment) in order to fulfill the obligations in the contract, then there might be an implicitly specified asset (subject to determining whether there are substantive substitution rights). See LG 2.3.1.4.
Example LG 2-1 and Example LG 2-2 illustrate the identification of implicitly specified assets.
EXAMPLE LG 2-1
Bank data center contract
Commercial Bank enters into a lease for a portion of its data center with Supplier Corp. The lease contract does not explicitly specify the equipment to be used to fulfill the contract; however, as a result of security measures in place for its customer data, Commercial Bank imposes specific restrictions on the equipment to be used. Although Supplier Corp has multiple data centers that are interchangeable and can service multiple customers at one time, the arrangement with Commercial Bank specifies the type of equipment to be used to fulfill its contract and imposes restrictions on access and substitution for the duration of the contract.
Does the contract specify an asset to be used to fulfill the contract?
Analysis
Yes. Although the assets used to fulfill the contract are not explicitly specified, the assets are implicitly specified as a result of the contractual requirements and specifications mandated by Commercial Bank.
EXAMPLE LG 2-2
Automobile hood ornament contract
Supplier Corp enters into a contract to provide Automobile Manufacturer with hood ornaments for its cars. The contract does not explicitly specify the equipment to be used to fulfill the contract. Supplier Corp designs and custom builds a die in the shape of Automobile Manufacturer’s logo specifically to produce the hood ornaments. Automobile Manufacturer is involved in ensuring the machine meets their specific standards.
Does the contract specify an asset to be used to fulfill the contract?
Analysis
Although the die is not explicitly specified in the arrangement, the contract is reliant on the die and therefore it is implicitly specified. While Supplier Corp is not contractually required to use a specific die, it is not feasible to utilize a different die. Therefore, the asset used to fulfill the contract would be the specialized die.

2.3.1.3 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 building is generally considered physically distinct. One floor within the building may also be considered physically distinct if it can be used independent of the other floors (e.g., point of entry or exit, access to lavatories). Similarly, the use of a static or electronic billboard on the facade of a stadium may be considered physically distinct from the use of the stadium as a whole if the location of the billboard is specified as a condition of the contract. Naming rights to a sports stadium typically involve co-branding and shared promotion, along with the right for the sponsoring entity to place its logo on the stadium. These rights are generally considered intangible assets and are outside the scope of the leasing guidance.
Certain assets may lend themselves to use by more than one party and need to be carefully evaluated to determine if they are physically distinct. For example, a contract providing the use of a portion that is less than substantially all 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. A portion of an asset that is not physically distinct is not an identified asset unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to obtain substantially all of the economic benefits from use of the asset. See LG 2.3.2.1 for additional information on evaluating whether the contract provides substantially all of the economic benefits from use of an asset.
Another example is a tenant that rents one floor in a multi-story office building. The floor of the building to be used by the individual tenant may be physically distinct. However, the tenant would also need to consider its right to use the land on which the building is located. While the land on which the entire building is located is physically distinct, the portion of the land that the tenant has the right to use, is not physically distinct. A tenant’s right to use a non-physically distinct portion of the land would be an identified asset only if such right is for substantially all of the capacity of the land. For example, if the tenant had the right to use nine floors in a ten-story building, it would be reasonable to conclude that the land in the arrangement is also an identified asset. Provided the other criteria for a lease were met, the tenant would have a lease of both the building and the land and would need to evaluate whether they represent separate lease components. In contrast, if the tenant had the right to use only two floors of the ten story building, it would only have a lease of the building and not of the underlying land. See LG 2.5 for additional information on identifying components within a lease.
A portion of a pipeline (such as a lateral pipeline) could be physically distinct if an entity can separate (e.g., through use of a valve) and use the portion of the asset independent of the mainline pipeline. “Last mile” assets (i.e., the end of a single, contiguous asset) would be evaluated in the same way. If the last mile is mechanically separable from the remainder of the asset (e.g., there is a switch that permits an entity to shut off the flow of electricity or signal to a power or telephone line), the asset would be considered physically distinct.
When thinking about whether an asset is physically distinct, entities may need to consider the nature of the asset and evaluate how the asset was designed to be used. This evaluation could include the type of functionality the asset will provide and to what parties it will be provided. For example, consider an arrangement that conveys the right to use a specific space on a cell phone tower to a customer. The primary use of the cell tower is to sell or rent space on the tower to cell phone carriers. As a result, the specific hosting locations on the cell tower are physically distinct.
In contrast, arrangements that provide use of a specific spot on an electric utility pole to a third party (i.e., a cell phone carrier) generally would not be considered physically distinct. The portion of a utility pole to be used by a third party generally cannot be physically or mechanically separated from the remainder of the pole. Further, the primary use of a utility pole is to support electrical wires and transport electricity (i.e., to permit the utility company to provide its core service). As the primary purpose is not to serve as a hosting device for third-party assets, it may be reasonable to conclude that the utility pole attachments would not be considered physically distinct.

2.3.1.4 Substantive substitution rights

The existence of substitution rights may result in the determination that a specific asset has not been identified. If an asset is implicitly specified because the supplier does not have any alternative assets available to fulfill the contract, substitution rights do not exist. If, however, an asset is explicitly specified in a contract, but the supplier has a contractual right to substitute that asset, the entities would need to evaluate the criteria in ASC 842-10-15-10 to determine if the substitution rights are substantive.

ASC 842-10-15-10

Even if an asset is specified, a customer does not have the right to use an identified asset if the supplier has the substantive right to substitute the asset throughout the period of use. A supplier’s right to substitute an asset is substantive only if both of the following conditions exist:
a. The supplier has the practical ability to substitute alternative assets throughout the period of use (for example, the customer cannot prevent the supplier from substituting an asset, and alternative assets are readily available to the supplier or could be sourced by the supplier within a reasonable period of time).
b. The supplier would benefit economically from the exercise of its right to substitute the asset (that is, the economic benefits associated with substituting the asset are expected to exceed the costs associated with substituting the asset).

When both of these criteria are met, the asset is not an identified asset irrespective of whether it is specified in the underlying contract.
Provisions that permit an alternative means for fulfilling a contract under certain circumstances may indicate that the customer does not have the right to use an identified asset. For example, a large manufacturing entity may enter into an agreement with a customer that specifies a particular model of equipment to be used to fulfill the contact. Although the model number is specified, if the manufacturer has several interchangeable pieces of equipment and can use any one of them to satisfy its obligations under the contract, the arrangement may not include an identified asset. Similarly, a contract that permits a supplier to outsource its obligation to deliver a product or service may not meet the identified asset criterion.
As discussed in ASC 842-10-15-14, a supplier's right to replace a specified asset during the term of an arrangement if it is not working properly or becomes defective is not considered a substantive substitution right (i.e., an identified asset would still exist) and would not by itself preclude the arrangement from being considered a lease. Likewise, a provision that contractually permits or requires a supplier to substitute other assets on or after a specified date does not preclude the arrangement from being considered a lease prior to the substitution date.
Question LG 2-1 discusses how customer approval affects substitution rights.
Question LG 2-1
Is a substitution right that requires customer approval considered substantive?
PwC response
No. A substitution right in a contract that allows substitution only with customer approval is not considered substantive.
Supplier has practical ability to substitute the asset
In addition to having a substitution right, a supplier must have a replacement asset that can perform the functions required under the arrangement. Contractual language is not sufficient alone; the parties to the contract should also consider the practical ability of the supplier to substitute the asset and to execute the substitution within a reasonable amount of time. This evaluation should be performed based on information available at contract inception and should exclude consideration of future events that are not considered likely to occur.
To evaluate whether the supplier has the practical ability to substitute the asset, all relevant factors, such as those discussed below, should be considered together.
  • Whether similar assets that can be used to satisfy the arrangement are readily available
  • Whether any obstacles to substitution, such as cost or physical feasibility exist (e.g., if the asset is located on the customer’s premises)
Supplier can benefit from exercising substitution right
In addition to having the practical ability to substitute one asset for another, the supplier must also benefit economically from the substitution (e.g., the benefit must exceed the cost of substitution) for it to be considered substantive. A supplier may be able to articulate the benefits of substitution and related costs, and it may even have a history of when substitutions have occurred to help guide its analysis. The customer, on the other hand, is likely to find this assessment more challenging.
For a customer, this analysis is similar to how it might consider the economic factors when evaluating whether purchase and renewal options are reasonably certain. See LG 3.3.3.1 for information on that analysis. In the case of substitution rights, the analysis primarily considers factors from the supplier’s perspective. Examples of factors to consider include:
  • Transportation costs of relocating one asset to a location where it can be used to satisfy the arrangement or to move the output from the production location to the customer 
  • Foregone production resulting from down time necessary to switch assets and other disruptions to the supplier’s and/or customer’s business 
  • Costs to convert an asset that may not have produced identical output 
  • Reduced production costs or increased production volume resulting from a more efficient version of an asset
There is no specific measurement threshold to be met; judgment is required to determine how significant the supplier’s economic benefits should be for the substitution right to be substantive, thereby precluding lease accounting.
Generally, a supplier will be in a better position to determine whether it can benefit from exercising a substitution right, but it may be obvious to a customer that the substitution right benefits the supplier when there is a clear economic incentive and the barriers to substitution are minimal. When the customer does not have adequate transparency to the practicality or economics of supplier substitution rights, it should assume that the substitution right is not substantive and that the arrangement contains an identified asset. When an asset resides on a customer’s premises, a supplier generally does not have a substantive substitution right because the costs and potential disruption would be significant.
Additionally, the assessment as to whether a substitution right is substantive should be based on facts and circumstances that exist at the inception of the contract. Any circumstances that are not likely to occur during the period of use would be disregarded in the analysis. While a supplier may use substitution rights to manage its assets, and historically substitutes assets across its portfolio, the parties should consider whether it is likely that a specific asset will be substituted while in use by a customer. For example, a car rental company that frequently substitutes cars while they are under contract to customers may be unable to support an assertion that substitution of a particular car under rental is likely to occur, because a typical car rental period is short. Thus, it may be difficult to apply an entity-wide assertion that substitution rights are substantive.
Consideration should also be given to whether the future events that might occur are within the supplier’s ability to influence. ASC 842-10-15-11 discusses future events that, at inception, are not considered likely to occur during the period of use. An example is a provision in a contract that allows the supplier to substitute the asset for new technology when it is available, but the technology is not substantially developed at inception of the contract. This would not be considered a substantive substitution right. Similarly, rights to substitute the asset predicated on government approval, changes in regulations, or expected changes in customers’ usage may not be substantive substitution rights. The analysis is performed at the inception of the arrangement and does not consider hypothetical or contingent changes. Rights that allow for the replacement of certain parts, or the asset as a whole, as a result of loss or wear and tear are not considered substantive substitution rights.
Example LG 2-3 illustrates a substitution rights that is substantive.
EXAMPLE LG 2-3
Supplier with substantive substitution rights
Warehousing Corp owns a large warehouse that can be subdivided into numerous subsections by inserting removable walls. It leases out different portions of storage space to its customers based on their respective needs.
Manufacturing Corp contracts with Warehousing Corp to reserve 1,000 square feet of space to store its excess inventory for a three-year period. The contract states that Manufacturing Corp’s inventory will be stored in a specified location in the warehouse. However, Warehousing Corp has the right to shift Manufacturing Corp’s inventory to another location within its warehouse at its discretion, subject to the requirement to provide 1,000 square feet for the three-year period.
Warehousing Corp frequently reorganizes its space to meet the needs of new contracts. The cost of reallocating space is low compared to the benefits of being able to accommodate as many customers as possible in the warehouse.
Does the contract contain an identified asset?
Analysis
No. While the contract explicitly specifies the location where Manufacturing Corp’s inventory will be stored, the asset is not identified because Warehousing Corp has a substantive substitution right. Warehousing Corp has agreed to provide a specific amount of storage space within its warehouse at a specific location. However, Warehousing Corp has the unilateral right to relocate Manufacturing Corp’s inventory. It would benefit by relocating the customer’s inventory and can do so without significant cost. As such, Warehousing Corp’s substitution rights are considered substantive, and there is not an identified asset.

Example LG 2-4 illustrates a substitution right that is not substantive.
EXAMPLE LG 2-4
Supplier without substantive substitution rights
Warehousing Corp owns a large warehouse that can be subdivided into numerous subsections by inserting removable walls. It leases out different portions of storage space to its customers based on their respective needs.
Manufacturing Corp contracts with Warehousing Corp to reserve 1,000 square feet of space to store its excess inventory for a three-year period. Warehousing Corp has the right to shift Manufacturing Corp’s inventory to another location within its warehouse at its discretion, subject to the requirement to provide 1,000 square feet for the three-year period. However, Manufacturing Corp specified in its contract that its materials must be stored at a specific temperature.
Warehousing Corp frequently reorganizes its space to meet the needs of new contracts; however, Warehousing Corp only has one location in its warehouse with a cooling system capable of maintaining the required temperatures based on the layout of its HVAC system.
Does the contract contain an identified asset?
Analysis
Yes. The asset is identified because Warehousing Corp does not have a substantive substitution right. Warehousing Corp has agreed to provide a specific level of capacity within its warehouse at a specific location within the warehouse and does not have the unilateral right to relocate Manufacturing Corp’s inventory without significant cost of installing additional cooling systems or modifying its HVAC system.

2.3.2 Right to control the use of an identified asset

Once a reporting entity concludes that the asset to be used is identified, the parties to the transaction must then evaluate whether the customer controls the use of that asset throughout the period of use. An arrangement is not a lease if it does not convey control over the use of an asset to the customer. A contract that does not convey control to the customer, even when the asset to be used to fulfill the contract is explicitly identified, is subject to the guidance applicable to a service or supply arrangement.
ASC 842-10-15-4 provides the requirements for a customer to have control over an asset.

ASC 842-10-15-4

To determine whether a contract conveys the right to control the use of an identified asset (see paragraphs 842-10-15-17 through 15-26) for a period of time, an entity shall assess whether, throughout the period of use, the customer has both of the following:
  1. The right to obtain substantially all of the economic benefits from use of the identified asset (see paragraphs 842-10-15-17 through 15-19)
  2. The right to direct the use of the identified asset (see paragraphs 842-10-15-20 through 15-26).
If the customer in the contract is a joint operation or a joint arrangement, an entity shall consider whether the joint operation or joint arrangement has the right to control the use of an identified asset throughout the period of use.

Utilizing all of an asset’s output may indicate that the customer is obtaining substantially all of the economic benefit; however, this alone is not enough to demonstrate control of the asset. The customer must also have the right to direct the use of the asset. Both criteria must be met to qualify for lease accounting.
The assessment of whether a reporting entity has control over an asset should consider the period of use of that asset. The period of use is defined in the ASC 842 Glossary as follows.

Definition from the ASC 842 Glossary

Period of Use: The total period of time that an asset is used to fulfill a contract with a customer (including the sum of any nonconsecutive periods of time).

Control over use of an asset can be for a consecutive period, nonconsecutive periods, or a portion of the term of the contract. In Example LG 2-5, a facility is used for two months each year over a five-year period; the period of use refers to those specified time periods within the year, not the entire year. ASC 842-10-15-5 provides guidance on a customer obtaining control for a portion of the term of a contract.

ASC 842-10-15-5

If the customer has the right to control the use of an identified asset for only a portion of the term of the contract, the contract contains a lease for that portion of the term.

Example LG 2-5 illustrates an arrangement in which control is obtained in nonconsecutive periods.
EXAMPLE LG 2-5
Contract for a nonconsecutive period of use
Customer Corp enters into a contract with Supplier Corp that grants Customer Corp exclusive rights to use a specific grain storage facility over a five-year period in the months of September and October. During these months, Customer Corp has the right to decide which crops are placed in storage and when to remove them. Supplier Corp provides the loading and unloading services for the warehouse activities. During the other ten months each year, Supplier Corp has the right to determine how the warehouse will be used.
Which party has the right to control the use of the identified asset during the period of use?
Analysis
Customer Corp has the right to control the use of the identified asset during the period of use because it has the power to determine how the warehouse will be used during the contractually-defined usage periods. The analysis should focus on the rights and economics of the use of the warehouse for the specified usage periods (September and October). During the period of use, Customer Corp has the rights to determine how much of a crop to place in storage, and the timing of placing and removing it from storage. These rights are more significant to the economics of the use of the asset than the loading and unloading services performed by Supplier Corp during the same period. Customer Corp receives all of the economic benefit from use of the asset during those specified time periods. The total period of time that the warehouse will be used to fulfil the contract is 10 months (2 months per year over the five-year period).

Determining the portion of the term of the contract during which a customer has the right to control the use of the identified asset may be more challenging when a substantive substitution right exists for a portion of the contract term. ASC 842-10-15-13 provides guidance on this situation.

ASC 842-10-15-13

If the supplier has a right or an obligation to substitute the asset only on or after either a particular date or the occurrence of a specified event, the supplier does not have the practical ability to substitute alternative assets throughout the period of use.

Example LG 2-6 analyzes a substantive substitution right only after a particular date.
EXAMPLE LG 2-6
Supplier with substitution right after a particular date
Warehousing Corp owns a large warehouse that can be subdivided into numerous subsections by inserting removable walls. It leases out different portions of storage space to its customers based on their respective needs.
Manufacturing Corp contracts with Warehousing Corp to reserve 1,000 square feet of space to store its excess inventory for a three-year period. The contract states that Manufacturing Corp’s inventory will be stored in a specified location in the warehouse. Within the first year of the arrangement, Warehousing Corp has the right to move Manufacturing Corp’s inventory to a different 1,000 square foot location within its warehouse at its discretion.
Does Warehousing Corp have a substantive substitution right?
Analysis
In this case, the substantive substitution right does not exist throughout the period of use. As such, Manufacturing Corp could have a lease of the warehouse space beginning in year two of the agreement, provided the other criteria are met.

2.3.2.1 Right to obtain substantially all the economic benefits

The first criterion in the control assessment is the right to the economic benefits derived from the asset. To be a lease, the arrangement must convey the right to obtain substantially all of the potential economic benefits that can be obtained from directing the use of the asset throughout the period of use. As discussed in LG 2.3.2, the period of use could be consecutive or nonconsecutive periods of time. A customer would not control an asset if another party has the right to more than an insignificant portion of the potential economic benefits. This is not a probability analysis as to who is likely to receive the benefits; the assessment should focus on the contractual rights of the respective parties. Specifically, the rights to the output and other economics derived from use of the asset should be considered. If a customer does not have contractual rights to all of the existing capacity of the asset, and the arrangement does not grant the customer an option to acquire any additional capacity, the arrangement is unlikely to be a lease. However, if the customer has the option to increase the volume of the output it consumes before it is given to additional customers (right of first refusal), the arrangement likely meets this criterion.
If the asset produces more than one type of output or benefit, this assessment should be made based on the fair value of the contractual rights. In other words, the assessment should be performed based on the potential economic returns associated with those contractual rights. The assessment should be based on the asset as it exists at the time of entering into the arrangement by considering the capacity level at which the asset is expected to operate, maintenance schedules, and type of physical asset. The standard does not define “economic benefits” but it does provide examples of ways the benefits can be obtained.

Excerpt from ASC 842-10-15-17

A customer can obtain economic benefits from use of an asset directly or indirectly in many ways, such as by using, holding, or subleasing the asset.

A customer may derive economic benefits from its use of an asset by producing goods for its own use or resale, providing services, or enhancing the value of other assets. The parties to the contract should consider the economic benefits that can be derived from the use of the asset but not benefits that are derived solely from ownership of the asset (e.g., proceeds from the sale of the asset).
A customer that contracts for the right to use an asset generally has a specific purpose or use of the asset in mind. However, assets can often function and produce various outputs during their operation in addition to what was initially contracted. Economic benefits should include cash flows derived from both the primary outputs and by-products. For example, a supplier that owns equipment to produce customized parts for its customer (an automobile company) may simultaneously sell the scrap metal to a third party. When evaluating whether it is obtaining substantially all of the economic benefits from use of the underlying equipment, the customer should consider the economics of the supplier selling the scrap metal in addition to the manufactured parts.
In some industries, there are unique attributes associated with an asset’s operation that may or may not be considered output of the asset but need to be considered for purposes of the economic benefit test. For example, renewable energy credits (RECs) produced by a solar generation facility have economic value and should be considered an economic output in the leasing analysis because they are a benefit relating to the use of the asset. Since the RECs are dependent on the output of a specified power plant, they should be factored into the benefits derived from operation of that asset.
Question LG 2-2 discusses the economic benefit of an asset when its output is sold to separate parties.
Question LG 2-2
If an owner of a solar facility sells its energy production and renewable energy credits to separate parties, which party has the right to obtain substantially all of the economic benefits of the solar facility?
PwC response
It depends. If both the energy production and the RECs are deemed to be more than insignificant to the total economics, then neither party would have the right to obtain substantially all of the economic benefits and lease accounting would not apply.
Some arrangements require the customer to share a portion of the cash flows derived from the use of the asset with the supplier or another party. These arrangements may not prevent the customer from having the right to the economic benefits derived from the asset; rather, they may contain additional consideration for the use of the asset. A common example is a payment from the customer to the supplier based on a percentage of the sales derived from use of the asset.
Agreements for the use of assets for which a customer cannot derive economic benefits on its own without other resources may still meet the definition of a lease if the customer meets the criteria necessary to direct the use of the asset. For example, a contract for the use of an asset of such a specialized nature that the supplier must operate it may still be deemed a lease if the customer has the ability to dictate when it runs, or has the ability to let it sit idle. In this case, the customer retains the right to direct the use of the asset during the term of the arrangement and can effectively prevent another party from obtaining the economic benefits.
Unit of account
In order to assess whether a customer obtains substantially all of the economic benefits from the use of an identified asset, the customer must first identify the parties that have the right to use the asset. As discussed in LG 2.3.2.1, certain agreements provide the customer with exclusive use of the identified asset during the period of use, while other arrangements provide for use of the asset by multiple parties. Determining whether more than one party has the right to use an identified asset requires identification of the unit of account. Identifying the unit of account may be straight forward for some arrangements. However, for certain contracts, like land easements, this determination may be more challenging.
Example LG 2-7 illustrates how to identify the unit of account in certain land easement agreements.
EXAMPLE LG 2-7
Easements – unit of account
On January 1, Tower Company enters into an arrangement to obtain the right to access farmland owned by Landowner for 40 years. The contract provides the right for Tower Company to access a specific plot of land measuring 10 acres. The contract also provides Tower Company with the right to construct a tower on an identified subsection of the 10-acre plot.
In accordance with the contract, Landowner has the ability to use the space not occupied by Tower Company’s assets for its own purposes, as long as the activities of Landowner do not interfere with the operation of Tower Company’s tower. Landowner does not have the ability to access the specified portion of the plot of land where the tower will be built.
What is the unit of account for assessing whether the agreement is or contains a lease?
Analysis
In this fact pattern, we believe there are two units of account.
The contract provides for surface land rights and conveys different rights between the site for the tower and the remainder of the acreage. Tower Company has exclusive use of the parcel where the tower will be constructed and shared access to the remaining property. Therefore, the agreement contains two units of account.
Tower Company would need to evaluate both the subsection of the land where the tower will be built and the remaining space not occupied by the tower to determine if either meets the definition of a lease. The agreement specifies the location of both units of account. As such, each is considered an identified asset. Tower Company has exclusive use of the specified parcel where the tower will be built, and thus has the ability to both (1) direct how this identified asset is used and (2) obtain substantially all of the economic benefits from it. As such, Tower Company has the right to control the use of that parcel of land, and the agreement contains a lease. Use of the remaining portion of the 10-acre land parcel is shared between Tower Company and Landowner. As such, Tower Company would need to evaluate whether it has the right to control the use of that portion of the land.
Tower Company would determine the stand alone selling prices for each unit of account at inception and would allocate consideration based on those amounts. Tower Company would recognize the consideration allocated to the tower site when the lease begins.
Note, if the subsection of land on which the tower will be constructed is not determined until June 30 (six months after the January 1 inception), there would still be two units of account at inception, and consideration would be allocated to each unit of account based on stand-alone selling prices at that date. However, because the lease would not commence until June 30 when the subsection is identified, any amounts allocated to the lease component would not be recognized until June 30. Accounting for arrangements that (1) involve the right to use an asset to be specified in the future and (2) contain more than one unit of account, can be challenging. The application of the model depends on the facts and circumstances of each arrangement, which should be carefully evaluated.
In ASC 842-10-65-1 (gg), the FASB provided guidance on an optional transition practical expedient to not evaluate under ASC 842 existing or expired land easements that were not previously accounted for as leases under ASC 840. Instead, reporting entities that elect this practical expedient would continue their current accounting for land easements that existed prior to the entity’s adoption date. All land easements arrangements entered into or modified after a reporting entity’s adoption date are required to be evaluated under ASC 842. This practical expedient can be elected independent of all other practical expedients. See LG 10 for further discussion of practical expedients and transition considerations.

2.3.2.2 Right to direct the use of the identified asset

The second criterion in the control assessment is the right to direct the use of the identified asset. Decisions about how and for what purpose an asset will be used are the most relevant factors to consider when assessing which party directs the use of the identified asset. A reporting entity should give the most weight to the factors that have the greatest impact on the economic benefit to be derived from that asset.
Figure LG 2-2 illustrates the analysis that should be used to determine which party has the right to direct the use of an identified asset.
Figure LG 2-2
Analysis of which party has the right to direct the use of an identified asset
Figure 2-2 Analysis of which party has the right to direct the use of an identified asset
ASC 842 includes guidance for determining which party has the right to direct the use of an identified asset under two broad scenarios: either all relevant decisions about how and for what purpose the asset is used during the period of use are predetermined, or they are not.
Under either scenario, the customer will generally be deemed to have the right to direct the use of the asset if, during the period of use, the customer may operate the asset, or may direct others do so without the supplier having the right to change that right. Operating an asset takes different forms depending on the nature of the asset. Determining whether a customer operates an asset may be straightforward when an asset requires active operations (e.g., construction equipment). Other assets require little active operation (e.g., storage containers) or are completely automated (e.g., a solar panel); and it may be more difficult to determine whether a customer operates such asset. However, a customer’s right to turn an asset on or off, to disconnect an asset from other assets, or to “pull the plug” (other than solely for safety or protective concerns) would generally be considered a right to operate the asset.
The next step is to identify all the “relevant” decisions that could be made during the period of use that can change how and for what purpose the asset is used. As described in ASC 842-10-15-24, a decision is considered “relevant” when they affect the economic benefits that could be derived from using the asset. Examples of these rights are outlined in ASC 842-10-15-25.

ASC 842-10-15-24

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. In making this assessment, an entity considers the decision-making rights that are most relevant to changing how and for what purpose an asset is used throughout the period of use. Decision-making rights are relevant when they affect the economic benefits to be derived from use. The decision-making rights that are most relevant are likely to be different for different contracts, depending on the nature of the asset and the terms and conditions of the contract.

ASC 842-10-15-25

Examples of decision-making rights that, depending on the circumstances, grant the right to direct how and for what purpose an asset is used, within the defined scope of the customer’s right of use, include the following:

  1. The right to change the type of output that is produced by the asset (for example, deciding whether to use a shipping container to transport goods or for storage, or deciding on the mix of products sold from a retail unit)
  2. The right to change when the output is produced (for example, deciding when an item of machinery or a power plant will be used)
  3. The right to change where the output is produced (for example, deciding on the destination of a truck or a ship or deciding where a piece of equipment is used or deployed)
  4. The right to change whether the output is produced and the quantity of that output (for example, deciding whether to produce energy from a power plant and how much energy to produce from that power plant).

Direct operations during the period of use
In some arrangements, the decisions related to how and for what purpose an asset is used, as outlined in ASC 842-10-15-25, are already specified in the contract before the lease term commences. Since these decisions are predetermined and are not made during the period of use, they are ignored as long as any relevant decisions could occur during the period of use. For example, the ability to change “where the output is produced,” as described in ASC 842-10-15-25 (c) may not apply to assets that are not portable. As such, that factor is ignored in this evaluation. Predetermined decisions are only considered when there are no relevant decision-making rights that could be made during the period of use. This principle is supported by an IFRS Interpretations Committee (a committee of the International Accounting Standards Board) decision published at its January 2020 meeting. (Although the US and IFRS Leases standards are not converged, the guidance on the right to determine how and for what purpose an asset is used is identical, and as such we believe that the Committee’s interpretation should be applied.)
The Committee considered a submission describing a voyage charter agreement in which the following conditions were predetermined in the contract:
  • A specified ship would be used to transport a specified quantity of a customer’s coal to a single destination. Neither the quantity nor the cargo could be changed
  • The quantity equaled the ship’s capacity
  • The contract designated three load ports. There was a predetermined number of voyages from each of the three load ports to the single destination (e.g., 10 trips from port A, seven from port B, and three from port C). The revenue per trip was fixed; accordingly, the total revenue to the lessor, and cost to the lessee, was fixed per the contract
  • The total number of voyages was predetermined, and would fully consume the ship’s capacity during the period of use
  • The supplier operated and maintained the ship
During the period of use, the customer could only choose the order in which the trips from each load port would occur. The facts assume that the order of the trips affected the economics derived from the use of the ship during the period of use. Since a relevant decision exists during the period of use, the Committee noted that all the predetermined decisions (which appear to be more impactful on the economics than the order in which the trips occur) should be ignored. Similarly, the supplier’s obligation to operate and maintain the ship is not relevant to determining which party had the right to direct the use of the asset during the period of use. Accordingly, in the fact pattern considered, the customer was deemed to direct the use of the ship during the period of use.
The right to determine how and for what purpose an asset is used is different than how those decisions are implemented. For example, when a customer outsources operation of an asset to an outside service provider, it may continue to direct how and for what purpose the asset is used; the outsourcing (i.e., physically operating the asset subject to the customer’s direction) does not typically influence the economic benefits that can be derived from the asset.
Similarly, if a customer must either approve, or could veto, a supplier’s decision, the customer is the decision maker, notwithstanding the supplier’s advice and know-how. That the supplier was hired for its expertise, and proposed the decision, is similar to the functions of a customers’ expert employee.
In evaluating the ability to change what an asset is used for during the period of use, or how, when, whether, and where the asset is used, one might encounter some decisions that are: (1) predetermined, or (2) directed by the customer, or (3) directed by the supplier, or any combination thereof. When evaluating which party has the right to direct the use of the underlying asset during the period of use, predetermined decisions are ignored (e.g., the site where an asset may be used); rather, the entities must consider whether the customer or the supplier directs the remaining relevant decisions that, in total, more significantly affect the economic benefits derived from the asset during the period of use.
Predetermined operations
If the contract explicitly states how and for what purpose an asset will be used throughout the term of the arrangement, and neither party can change how and for what purpose the asset is used during the period of use, then different factors should be considered to determine which party is directing the use of the asset as discussed in ASC 842-10-15-20(b).

Excerpt from ASC 842-10-15-20

A customer has the right to direct the use of an identified asset throughout the period of use in either of the following situations:

  1. ...
  2. The relevant decisions about how and for what purpose the asset is used are predetermined (see paragraph 842-10-15-21) and at least one of the following conditions exists:
  3. The customer has the right to operate the asset (or to direct others to operate the asset in a manner that it determines) throughout the period of use without the supplier having the right to change those operating instructions.
  4. The customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use.

A reporting entity should consider whether any variability is created during the operation of the asset, in order to determine whether there are any relevant decisions that are made during the period of use. If so, the design of the asset is not used to determine which party directs the right to use the asset during the period of use.
Design of the asset
For certain types of assets, their design is the primary factor in determining the resulting economics. This is especially true when the design establishes how and when an asset is to be used. For example, a customer that contracts to buy electricity from a supplier’s windfarm that is responsible for locating the site and the number of turbines to be used to generate the electricity it purchases, may have the right to direct the use of the asset because there are no relevant decisions that could be made during the period of use that can be derived from the asset (i.e., because the electrical output is dependent on how often the wind blows in a location selected by the customer). How the asset is to be used and for what purpose has been predetermined through the selection of the site and design of the asset.
In certain cases, the level of a customer’s involvement in the design of the asset may be unclear. In that case, whether the customer was the sole decision maker for the most significant design decisions should be considered to determine whether the customer made the decisions that established the design of the asset. If the decisions were jointly made by the customer and the supplier, then it will be presumed that the customer did not make the decisions that pre-determined the design of the asset.
Other considerations
As discussed in ASC 842-10-15-23, an owner/supplier’s protective right to inspect their asset to ensure it is being operated properly and maintained sufficiently should not be a factor in determining who controls the asset. These rights are not decision making rights.

2.3.2.3 Examples — right to control the use of an identified asset

Example LG 2-8, Example LG 2-9, Example LG 2-10, Example LG 2-11, Example LG 2-12, and, Example LG 2-13 illustrate the determination of which party has the right to control the use of an identified asset.
EXAMPLE LG 2-8
Consideration of dispatch rights
Customer Corp contracts with Supplier Corp to manufacture parts in a facility on Customer Corp’s property. Customer Corp designed the facility and stipulates its specifications. Supplier Corp owns the facility and leases the land from Customer Corp. Customer Corp specifies how many parts it needs and when it needs the parts to be available. Supplier Corp operates the machinery and makes all operating decisions including how and when the parts are to be produced, as long as it meets the contractual requirements to deliver the specified number on the specified date.
Which party has the right to control the use of the identified asset (i.e., building and equipment) during the period of use?
Analysis
Customer Corp does not direct the use of the asset that most significantly drives the economic benefits because Supplier Corp determines how and when the building and equipment are operated once the contract is signed. Therefore, Supplier Corp has the right to control the use of the identified asset during the period of use. Although Customer Corp stipulates the product to be provided and has input into the initial decisions regarding the use of the asset through its involvement in the design of the asset, Customer Corp does not have dispatch rights (i.e., the right to control the output at a given time). As such, Customer Corp does not have decision making rights over the asset during the period of use. This arrangement would be a supply agreement, not a lease.
Determining whether a supplier or a customer has dispatch rights in a supply arrangement can be challenging. The evaluation should be based on the specific facts and circumstances of the arrangement. In making this assessment, companies should consider the following factors:
  • Can the product be inventoried and stored by the supplier? A supplier’s nominal ability to control the production schedule may not be substantive when it is impractical to store the output.
  • What is the typical lead time on orders? A short lead time may be indistinguishable from a dispatch right.
  • How long is the interval between orders? Very short intervals may be indistinguishable from a dispatch right.
  • Does the customer provide sufficient notice for orders such that a supplier can decide when to produce the required quantity or do customer orders dictate timing and level of the supplier’s production?

EXAMPLE LG 2-9
Illustration of dispatch rights
Customer Corp enters into contract to purchase energy from Supplier Corp; Supplier Corp owns a pre-constructed natural gas-fired power generation facility. Customer Corp has contracted for power from the asset on an as-needed basis to fulfill its power needs during peak periods of demand, but not on a constant basis. Customer Corp will notify Supplier Corp when to generate power to satisfy its needs. Customer Corp contracts for the right to all of the plant's capacity (100% of the electricity that can be generated) and therefore is entitled to all of the output. Customer Corp may allow the plant to sit idle at times of low demand.
Supplier Corp is responsible for operating and maintaining the asset throughout the term of the contract.
Which party has the right to control the use of the identified asset during the period of use?
Analysis
Customer Corp directs the use of the asset during the term of the contract through its right to dictate when the asset should operate and produce energy; the economics are most significant when the plant is operating and generating electricity. Since Customer Corp controls the decision to operate the asset (even though Customer Corp does not physically operate the facility), it has the right to direct the use of the asset that most significantly affects the economic benefits derived from its use, and therefore Customer Corp controls the identified asset during the term of the contract. In contrast to Example LG 2-8, Customer Corp is making decisions about the use of the asset during the period of use.
EXAMPLE LG 2-10
Illustration of lack of dispatch rights
Customer Corp enters into contract to purchase energy from Supplier Corp; Supplier Corp owns a pre-constructed natural gas-fired power generation facility. Customer Corp was not involved in the design of the facility. Customer Corp has contracted for power from the asset on a full-time basis. Customer Corp will purchase all of the plant's capacity (100% of the electricity that can be generated) and therefore is entitled to all of the output.
Supplier Corp is responsible for operating and maintaining the asset throughout the term of the contract.
Which party has the right to control the use of the identified asset during the period of use?
Analysis
It depends. The contract is for full-time operation; therefore, Customer Corp does not have dispatch rights. The parties must identify any relevant decisions that could be made during the period of use. In this fact pattern, whether and where the output is produced is predetermined by the terms of the contract and the nature of the asset. The parties should evaluate whether either party can change how much output is generated, and when it is generated. If Customer Corp makes those decisions, then it has the right to direct the use of the asset during the period of use. If Supplier Corp makes those decisions, (or if those decisions are predetermined by the terms of the contract), then Customer Corp does not have the right to direct the use of the identified asset.
EXAMPLE LG 2-11
Contract for the use of gas pipelines
Customer Inc enters into a five-year agreement with Supplier LP for 100% of the capacity of a specified natural gas pipeline. Supplier LP operates and maintains the pipeline. Customer Inc pays a fixed capacity charge each month. When Customer Inc chooses to use the capacity, it also pays a variable amount for each unit of natural gas transported. Supplier LP cannot use the pipeline capacity to transport natural gas for any other customer.
Which party has the right to control the use of the identified asset during the period of use?
Analysis
Customer Inc has the right to control the use of the identified pipeline during the period of use. Customer Inc makes the relevant decisions about how and for what purpose the pipeline will be used by determining when and how much natural gas will be transported through the pipeline. Customer Inc also has the right to obtain substantially all of the economic benefits from the transportation of natural gas through the pipeline because no one else can use the pipeline during the period of use.
EXAMPLE LG 2-12
Contract for use of manufacturing lines
Manufacturing Co enters into an arrangement with Supplier Corp for use of Supplier Corp’s manufacturing lines over a five-year period. Manufacturing Co notifies Supplier Corp when the lines are to be used based on Manufacturer Co’s production needs. Supplier Corp does not have substantive substitution rights and cannot use the manufacturing lines for any other purpose.
Which party has the right to control the use of the identified asset during the period of use?
Analysis
It depends. If the ordering process is in substance a dispatch right (e.g., the manufacturing lines are only used to produce Manufacturing Co’s product on the basis of, and only to the extent of, purchased orders issued by Manufacturing Co during the contract period), the arrangement would contain a lease since Manufacturer Co is making the relevant decisions that impact how and for what purpose the manufacturing lines are used. In this scenario, (a) Manufacturer Co would receive substantially all of the economic benefit from the exclusive use of the identified manufacturing lines, and (b) Manufacturer Co would have the ability to determine when, whether, and how often the lines would be used based on its purchase orders.
If, however, the ordering process is not in substance a dispatch right (i.e., Supplier Corp has flexibility to determine the capacity at which to run the manufacturing lines when purchase orders are received), Manufacturer Co may merely be ordering product, and the arrangement would not contain a lease because Manufacturer Co would not be making relevant decisions that impact how and for what purpose the asset is used.
EXAMPLE LG 2-13
Contract for use of an airplane over a three-year period
Sports Franchise enters into a contract with Supplier Corp for airplane transportation on an identified asset for Sports Franchise’s players for a three-year period. Sports Franchise provides the dates of travel and the arrival and departure locations at least one week in advance of each trip, which is not predetermined in the contract terms. Sports Franchise will pay Supplier Corp a fixed fee per month for use of the airplane.
Supplier Corp provides the airplane, crew, and pilot for each flight.
Which party has the right to control the use of the identified asset during the period of use?
Analysis
Sports Franchise has the right to control the asset because it can decide how and when the plane will be utilized during the period of use. Although Supplier Corp can make operational decisions about the flight plan, it is Sports Franchise who determines when the plane will fly. The frequency and distance traveled are more relevant to the overall economic benefits to be derived from the airplane than the specific routes of each individual trip.
In addition to the lease, the contract contains other nonlease components, such as the services provided by the pilot and crew, fuel, maintenance, and parking the airplane when not in use. See LG 2.4 for further information on lease and nonlease components.
Additionally, ASC 842 contains the following example of a contract for network services that is not a lease.

Example 10—Contract for Network Services

Customer enters into a contract with a telecommunications company (Supplier) for network services for two years. The contract requires Supplier to supply network services that meet a specified quality level. To provide the services, Supplier installs and configures servers at Customer’s premises; Supplier determines the speed and quality of data transportation in the network using the servers. Supplier can reconfigure or replace the servers when needed to continuously provide the quality of network services defined in the contract. Customer does not operate the servers or make any significant decisions about their use.

The contract does not contain a lease. Instead, the contract is a service contract in which Supplier uses the equipment to meet the level of network services determined by Customer.

Customer does not control the use of the servers because Customer’s only decision-making rights relate to deciding on the level of network services (the output of the servers) before the period of use—the level of network services cannot be changed during the period of use without modifying the contract. For example, even though Customer produces the data to be transported, that activity does not directly affect the configuration of the network services and, thus, it does not affect how and for what purpose the servers are used. Supplier is the only party that can make decisions about the use of the servers during the period of use. Supplier has the right to decide how data are transported using the servers, whether to reconfigure the servers, and whether to use the servers for another purpose. Accordingly, Supplier controls the use of the servers in providing network services to Customer. There is no need to assess whether the servers are identified assets because Customer does not have the right to control the use of the servers.

This example describes how entities would assess which party has the right to control the use of an asset when it is evident that the customer has the right to obtain substantially all the output of the asset and the asset cannot be substituted. In this example, the assets are located on Customer’s premises, and Customer presumably has the right to substantially all the output. ASC 842-10-55-126 concludes that Supplier controls the assets, notwithstanding that Customer appears to have the right to direct the use of the assets. Like Example LG 2-9, it appears that Customer has the ability to use the network assets on demand (i.e., dispatch rights), because Customer’s usage pattern would determine the timing and volume of the assets’ usage. For example, Customer determines when to transmit data and how much data is stored or transmitted.
The analysis as to which party has the right to control the use of an asset requires judgment. It may be appropriate to follow the principle in this example when the following circumstances are present:
  • The supplier uses multiple assets to fulfill its obligations to the customer.
  • The assets have more than one capability (i.e., each asset can perform several tasks).
  • The assets’ capabilities overlap, such that the supplier can make genuine decisions about how to deploy the multiple assets to fulfill its overall obligations to the customer. For example, throughout the usage period of the agreement, the supplier could decide whether and when to use either Server A or Server B to store data or to run network security tests, and the supplier could decide whether and when to reconfigure Servers A or B to enhance efficiency.
  • The supplier’s decisions are not subordinate to the customer’s explicit or implicit approval. For example, if the customer’s usage pattern could impede the supplier from exercising its decisions about which of the multiple assets could be used to perform a particular task, the supplier may not have the substantive right to direct the use of that asset. Accordingly, this example would more likely apply when the supplier uses the assets to fulfill a broader promise to the customer (as opposed to when the customer is contracting for the direct output of the particular asset).
When these circumstances do not exist, an entity should consider whether the arrangement more closely resembles the contract to purchase electricity on an on-demand basis in Example LG 2-9.
We believe this example was written to demonstrate only the particular decision as to which party has the right to direct the use of an asset; it does not address whether there are other components within an arrangement that should be accounted for as lease components. For example, the servers in the example may not be leased, but a different conclusion might be reached for the communication equipment (e.g., modems, routers) within the arrangement.
Expand

Welcome to Viewpoint, the new platform that replaces Inform. Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory.

Your session has expired

Please use the button below to sign in again.
If this problem persists please contact support.

signin option menu option suggested option contentmouse option displaycontent option contentpage option relatedlink option prevandafter option trending option searchicon option search option feedback option end slide