ASC 842 Leases (FAR): classify, set the lease term, measure the liability and ROU asset, and handle sale‑leasebacks

The rules, one page each

1. Lease term under ASC 842: include renewal options and when to reassessContrasting cases

   At commencement, include in the lease term any options the lessee is reasonably certain to exercise. Reassess the lease term only upon a significant event or change in circumstances that is within the lessee’s control and that affects whether the lessee is reasonably certain to exercise (or not) an option.

2. Short‑term lease exception: the 12‑month rule, renewals, and purchase optionsStep by step

   A short‑term lease is one with a lease term of 12 months or less at commencement and no purchase option that the lessee is reasonably certain to exercise. The lease term includes noncancelable periods and any renewal periods the lessee is reasonably certain to exercise; exclude options not reasonably certain.

3. Finance or operating lease? Lessee classification under ASC 842Decision tree

   A lessee classifies a lease as finance if any one of these is met: (1) ownership transfers by end of term, (2) a purchase option is reasonably certain to be exercised, (3) lease term is for a major part of remaining economic life, (4) present value of lease payments equals or exceeds substantially all of fair value, or (5) the asset is so specialized it has no alternative use. Otherwise, classify as operating. Optional periods that are reasonably certain are included in the lease term for this analysis.

4. ASC 842: Which payments are in the lease liability?Sort it

   At commencement, a lessee includes in the lease liability unpaid fixed payments, variable payments that depend on an index or rate measured using the index or rate at commencement, and amounts probable of being owed under residual value guarantees. Exclude usage- or sales-based variable amounts and consideration for nonlease components unless the lessee elected to combine components; include only payments for the lease term, including options that are reasonably certain.

5. ASC 842: Calculate lease liability and ROU asset (example)Worked example

   The lease liability equals the present value of unpaid lease payments. The ROU asset equals the lease liability adjusted for amounts paid at or before commencement (prepaid rent), lease incentives received (deduct), qualifying initial direct costs (add), and other required adjustments.

6. ASC 842 sale-leaseback: qualify sale and recognize gainStep by step

   If the transfer qualifies as a sale under ASC 606, the seller-lessee derecognizes the asset, recognizes any gain or loss immediately, and records a new ROU asset and lease liability for the leaseback. If control does not transfer (for example, due to a repurchase right), account for the transaction as a financing. Adjust off-market terms to fair value and eliminate related-party sale-leasebacks in consolidation.