Determining the Lease Term Under ASC 842
While there are various key concepts in applying lease accounting under ASC 842, this blog post will focus on determining the lease term from the lessee’s perspective.
The determination of the lease term under ASC 842 is integral to determining lease payments, lease classification and the measurement of lease assets and lease liabilities.
ASC 842 overview
All leases, with an exception for lessees for short term leases via an accounting policy election, are required to be recorded on the balance sheet under ASC 842. When a lessee recognizes a lease in the balance sheet, the lessee will record a lease liability (a liability to make lease payments) and a corresponding right-of-use asset, which represents the right to use the underlying asset for the lease term.
Note that this recognition entry is the same regardless of whether the lease is an operating lease or a finance lease.
ASC 842 defines a lease as “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”.
The definition of a lease requires two key criteria be met:
- There must be an identified asset; and
- The lessee must have the right to control the use of the identified asset
Check out this blog post which summarizes our various courses available on accounting for leases under ASC 842.
The lease term under ASC 842
The lease term represents the period of use for the asset. This is the period over which the lease payments will be recognized. Therefore, determining the correct lease term will have a direct impact on the recorded lease assets and liabilities.
The lease term is not just the non-cancelable term. Other factors must be evaluated, such as:
- Optional renewal periods
- Periods after an optional termination date
- Lessor options to extend a lease
Keep in mind, there is often judgment involved when determining the lease term.
Check out this video for more information on determining the lease term and why it’s such an integral part of accounting for leases!
Final thoughts
There are a number of other key concepts in addition to the lease term that lessees and lessors apply to identify, classify, recognize, and measure lease contracts under ASC 842. To learn more, check out our Leases technical topic page where we discuss other accounting considerations, compare ASC 842 to IFRS 16, and provide links to all of our lease courses and other helpful resources!
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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.
