BLOGS
Identifying Embedded Leases Under ASC 842

- Joint operating agreements such as with drilling rigs
- Promotion and Advertising contracts – dedicated billboards
- Transportation and delivery services – dedicated railway rolling stock
- IT service contracts – dedicated servers at external data centers
- Cable and satellite service commitments – dedicated set-top boxes or dishes
- Not every lease contract will contain the word “lease”.
- Is there an identifiable asset in the contract?
- Is there a right to obtain substantially all of the identified asset’s economic benefits?
- Is there a right to direct the use of the identified asset?
- If the answer to any of 2, 3 or 4 is “no” then no lease exists but otherwise, a lease does exist.
- A lease exists if the contract conveys the right to control the use of an identified asset over a period for consideration.
- That asset may include plant, property, vehicles or equipment.
- Embedded leases will be found in contracts covering “larger arrangements” such as those highlighted above.
- The supplier of the service is prohibited from using another asset.
- In a storage contract, rack space is dedicated to the client.
- There is no asset substitution option in the contract for the supplier
- The service agreement requires dedicated equipment such as servers, pipelines, microwave dishes in order for the supplier to fulfill the contractual obligations.
Summary
Identifying embedded leases requires judgement and a deep understanding of the business. In the future businesses will need to check contracts for embedded leases each time agreements are entered into or modified to ensure any necessary disclosures are calculated and declared. The challenge for many businesses regarding these lease components is that- they will inevitably fall outside of the internal standard lease identification process.
- they are faced with restatement and internal control risk if they do fail to identify and properly account for any agreements with embedded lease components.
Disclaimer: this article contains general information about the new lease accounting standards only and should NOT be viewed in any way as professional advice or service. The Publisher will not be responsible for any losses or damages of any kind incurred by the reader whether directly or indirectly arising from the use of the information found within this article.