Lease Agreement Evaluation Under ASC 842 | GBQ

Evaluating Lease Agreements & Overall Scope

When evaluating your lease portfolio, all three of the following conditions must exist to be a lease:

  1. An identified asset exists
  2. The lessee has the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use
  3. The lessee has the right to direct how and for what purpose the identified asset is used throughout the period of use

Once you have determined if your agreement constitutes a lease, there is additional information needed to calculate the right of use asset and obligation, including:

  • What term should be used?
  • When is the date of control? (i.e., Under 842 classification starts at lease commencement)
  • Should renewal options be included?
  • Is there a variable rent component to include? (For example, CPI adjustments or Percentage Rent)
  • What non-lease components are fixed?
  • Are multiple units included in the lease payment (e.g., equipment)?

The lease standard does provide for relief under certain practical expedients. The first three must be adopted on an “all or nothing” approach. The remaining items may be chosen independently.

  1. No reassessment of lease classification for existing leases.
  2. No reevaluation of existing/expired contracts for embedded leases.
  3. No reassessment of previously recorded initial direct costs.
  4. Hindsight expedient (lease terms, options, etc.).
  5. Combination of lease and non-lease components (i.e., fixed lease payments excluding executory costs such as CAM, insurance, etc.).
  6. Permitted to use a risk-free interest rate if there is no discount rate implicit in a lease contract.
  7. Land easement expedient.

Calculating the Lease Obligations & Right-of-Use Assets

Under ASC 842, initial operating lease liabilities and finance lease liabilities are calculated using the exact same method.

  1. Calculate the lease obligation value as the present value of future remaining lease payments and policies elected above
  2. Calculate the right-of-use asset, which starts with the lease obligation value adjusted for the following upon implementation:
    • Prepaid rent
    • Accrued rent
    • Lease incentives
    • Tenant Improvement allowances
    • Unamortized initial direct costs (IDC)
    • Deferred rent
    • Closed store reserve
    • Impairment
As detailed above, there are nuances to the lease standard when calculating right-of-use assets and lease obligation liabilities; therefore, working with a professional, such as a CPA, provides management with another resource for technical knowledge. If you would like to talk through your approach, your GBQ team is here for you.