FAR · Select transactions · 6 practice questions
ASC 842: Which payments are in the lease liability?
At commencement, include unpaid fixed payments, index-based amounts measured using the commencement index, and probable residual value guarantees. Below: a sort exercise to practice what is in or out, plus 20 free FAR questions.
Try one first
Hint
Separate variable payments based on an index or rate from variable payments based on performance. Then ask which version of the index is used at commencement.
Answer C. For a lessee under ASC 842, variable lease payments based on an index or rate are included in the initial lease liability using the index or rate at commencement. By contrast, payments based on sales are excluded from the initial measurement because they depend on future performance. Therefore, Lark initially measures the lease liability using $80,000 base rent plus the $5,000 CPI-based amount determined from the commencement-date CPI, without forecasting later CPI changes.
Why not A: This distractor overgeneralizes that 'variable payments are excluded.' Variable payments tied to an index or rate (such as CPI) are treated differently under ASC 842 and are included in the initial measurement using the commencement-date index.
Why not B: This is tempting because the stem provides expected sales, which can make candidates think those amounts should be included if reasonably estimable. However, sales-based variable lease payments are excluded from the initial lease liability and are recognized when the sales occur; only the CPI-based amount (using the commencement index) is included initially.
Why not D: This choice correctly excludes the sales-based amounts but is incorrect because initial measurement uses the index at commencement only; you do not forecast future CPI increases when determining the initial lease liability under ASC 842.
Sort it
Include if fixed, or variable based on an index or rate measured using the commencement index/rate, or a probable residual value guarantee, for periods in the lease term.
Exclude if variable based on usage or performance, or if in optional periods not reasonably certain, or if amounts are not probable.
Exclude consideration for separately stated nonlease services when components are not combined.
Adjust the ROU asset (not the liability) for payments at or before commencement, initial direct costs, and lease incentives.
| Item | Goes to |
|---|---|
| Fixed base rent due each period in the lease term | Include in the initial lease liabilityFixed payments are included in the initial lease liability. |
| CPI-linked variable payments measured using the commencement-date CPI | Include in the initial lease liabilityIndex-based variable payments are included using the index at commencement. |
| Expected CPI increases after commencement | Exclude from the initial lease liability; recognize when incurredDo not forecast index changes; recognize later changes prospectively when incurred unless remeasurement is required. |
| Sales-based variable rent (percent of sales) | Exclude from the initial lease liability; recognize when incurredPerformance-based variable payments are excluded initially and expensed when sales occur. |
| Usage-based variable payments (machine hours or units produced) | Exclude from the initial lease liability; recognize when incurredUsage-based variable payments are excluded initially and recognized when incurred. |
| Probable amount owed under a residual value guarantee | Include in the initial lease liabilityInclude the amount probable of being owed under the residual value guarantee. |
| Residual value guarantee contractual maximum cap | Exclude from the initial lease liability; recognize when incurredInclude only the probable amount, not the maximum cap, in initial measurement. |
| Payments in optional renewal periods when not reasonably certain to renew | Exclude from the initial lease liability; recognize when incurredOptional periods are excluded unless the lessee is reasonably certain to exercise the option. |
| Payments in optional renewal periods when reasonably certain to renew | Include in the initial lease liabilityPayments for options that are reasonably certain are part of the lease term and included. |
| First payment made at or before commencement | Affects only the right-of-use asset at commencementPayments at or before commencement are excluded from the lease liability and increase the initial right-of-use asset. |
| Separately stated maintenance service fee (components separated) | Nonlease components excluded from lease liabilityNonlease services are accounted for separately and excluded from the lease liability when components are not combined. |
| Initial direct costs paid to a third-party broker | Affects only the right-of-use asset at commencementQualifying initial direct costs are added to the ROU asset; they are not included in the lease liability. |
| Cash lease incentive received from the lessor at commencement | Affects only the right-of-use asset at commencementLease incentives reduce the initial right-of-use asset; they do not reduce the lease liability. |
| Purchase option price when not reasonably certain to be exercised | Exclude from the initial lease liability; recognize when incurredInclude a purchase option price only if the lessee is reasonably certain to exercise it at commencement. |
Key points
- Use the commencement-date CPI or rate to measure index-based amounts; do not forecast changes.
- Only payments not yet paid at commencement are in the lease liability; amounts paid at or before commencement adjust the right-of-use asset.
- Include payments for optional periods only if the lessee is reasonably certain to exercise the option.
- Include the probable amount under a residual value guarantee, not the contractual maximum.
- Sales- or usage-based variable payments are excluded initially and recognized when incurred.
- If lease and nonlease components are separated, nonlease services are excluded from the lease liability.
How the exam traps you
- Including sales- or usage-based variable payments in the initial lease liability. Exclude performance- and usage-based amounts; expense them when the underlying sales or usage occurs.
- Failing to separate maintenance or other nonlease services from lease payments. Exclude separately stated nonlease components from the lease liability unless the practical expedient to combine was elected.
- Projecting future CPI changes into the initial liability. Measure CPI-linked amounts using the index at commencement; later changes are recognized prospectively when incurred unless remeasurement is required.
- Including optional-period payments that are not part of the lease term. Include renewals only if the lessee is reasonably certain to exercise the option; otherwise exclude them.
Question 2
Hint
Separate the measurement issues: first identify what belongs in the lease liability, then determine what adjusts the right-of-use asset.
Answer D. Because Noll did not elect the practical expedient to combine lease and nonlease components, the fixed maintenance amount is a separate nonlease component and must be excluded from the lease liability. Usage-based charges that depend on future production and are not based on an index or rate are variable lease payments excluded from the initial lease liability, while the amount probable under a residual value guarantee is included. The lease liability is measured using Noll's incremental borrowing rate when the implicit rate is not readily determinable. The right-of-use asset equals the lease liability adjusted for initial direct costs (add the broker commission) and reduced by lease incentives received (subtract the cash incentive).
Why not A: This is tempting because the maintenance amount is fixed and included in the contractual payments. However, because Noll did not elect the practical expedient to combine lease and nonlease components, the maintenance services are a separate nonlease component and should be excluded from the lease liability.
Why not B: This overgeneralizes contingency rules. The residual value guarantee, when Noll concludes it is probable it will owe $25,000, is included in the lease liability. Service payments here are nonlease components and are excluded from the liability, not ignored as contingencies. The broker commission is an initial direct cost included in the ROU asset, and the lessor's cash incentive reduces the ROU asset rather than being immediately expensed.
Why not C: This distractor bundles two common errors: capitalizing variable usage-based payments and ignoring the residual value guarantee. Under ASC 842, usage-based payments not linked to an index or rate are excluded from initial lease measurement and accounted for as incurred, while amounts probable under a residual value guarantee are included. Also, initial direct costs such as a broker commission are added to the ROU asset rather than reducing it.
Question 3
Hint
At commencement, sort each item into three buckets: included in the lease liability, affects only the right-of-use asset, or excluded until later because it depends on future use or a not-reasonably-certain option.
Answer A. At commencement, include fixed lease payments and variable payments that depend on an index or rate using the commencement-date index; amounts probable of being owed under a residual value guarantee are also included in the lease liability. Usage- or performance-based variable payments (e.g., amounts tied to units produced) are excluded from the initial lease liability. Renewal payments are included only if the lessee is reasonably certain to exercise the option. The right-of-use asset is reduced by lease incentives received and increased by incremental initial direct costs such as the third-party commission.
Why not B: This is tempting because candidates may want to estimate all expected outflows, but ASC 842 excludes usage- or performance-based variable payments from initial measurement while including variable payments that depend on an index using the commencement-date index. Also, a probable residual value guarantee is included at commencement, and lease incentives received reduce (not increase) the lessee's right-of-use asset.
Why not C: This distractor relies on the idea that any variability is excluded initially. However, index- or rate-based payments are included using the commencement-date index, and probable amounts under a residual value guarantee are included. Lease incentives paid by the lessor do affect the lessee's right-of-use asset.
Why not D: This answer overweights the mere existence of an option and expected future usage. Renewal payments are included only when exercise is reasonably certain, and production-based variable payments are excluded from initial measurement. By contrast, a probable residual value guarantee is included, and lease incentives reduce the lessee's right-of-use asset.
Question 4
Hint
Identify which variable payments are indexed to a rate (include at commencement) versus those that depend on future performance (exclude); treat maintenance as a nonlease component unless combined.
Answer C. ASC 842 requires including fixed payments and variable payments that depend on an index or rate, measured using the index at lease commencement. Alder therefore includes the $90,000 fixed rent plus the CPI-linked $4,000 (measured using the commencement CPI), for $94,000 per year before discounting. Sales-based payments depend on future performance and are excluded at initial measurement, and the $6,000 maintenance is a separate nonlease component (Alder did not combine components), so both are excluded.
Why not A: Tempts because it is just the fixed base rent. It fails because it omits the CPI-linked variable payment, which ASC 842 requires be included at commencement using the index in effect at that date.
Why not B: Tempts by including both the CPI-linked amount ($4,000) and the expected sales-based amount ($8,000) in addition to the $90,000 base rent (90 + 4 + 8 = 102). It fails because sales-based variable payments depend on future performance and are excluded from the initial lease liability under ASC 842, even though CPI-linked payments are included.
Why not D: Tempts by treating all contractual outflows as lease payments (90 + 4 + 8 + 6 = 108). It fails because the $6,000 maintenance is a nonlease component (and Alder did not combine components), so it is excluded, and sales-based payments are excluded as performance-based variables.
Question 5
Hint
Focus on which lease payments belong in the lessee's initial lease liability and which are recognized only as they occur.
Answer B. Under ASC 842 a lessee recognizes a lease liability and right-of-use asset at lease commencement for leases that are not short-term. The initial liability includes fixed lease payments (and certain other specified amounts) but excludes variable payments that depend on the lessee's sales because those are not based on an index or rate. Sales-based variable payments are expensed in the period the related sales occur.
Why not A: This is tempting because candidates may think the liability should reflect all expected cash outflows. However, sales-based variable payments are excluded from initial measurement when they do not depend on an index or rate, so estimating and capitalizing them at commencement would be incorrect.
Why not C: This reflects an outdated off-balance-sheet view. ASC 842 requires recognition of a lease liability and right-of-use asset at commencement for leases that are not short-term; only the sales-based variable portion is excluded from initial measurement and recognized as incurred.
Why not D: The right-of-use asset is recognized at lease commencement when the lessee obtains the right to use the asset, not when the first payment is made. Both the liability and the ROU asset are recorded at commencement (for non-short-term leases).
Question 6
Hint
Separate the classification question from the measurement question. Then ask which cash flows are lease payments at commencement and which are variable or nonlease amounts.
Answer C. This meets the finance-lease criterion because the asset is so specialized that it is expected to have no alternative use to the lessor at the end of the term. Initial lease liability includes the present value of fixed lease payments (the $424,000). Variable payments based on sales are excluded from the initial liability and are recognized when incurred, and separately stated maintenance (a nonlease component) is excluded because Birch did not elect the practical expedient to combine components.
Why not A: This distractor is plausible because the 4-year term is less than the 10-year economic life, but ASC 842 allows a lease to be classified as a finance lease if any one of the criteria is met. The specialized-asset/no-alternative-use criterion is met here, so it is a finance lease even though the liability equals $424,000.
Why not B: Sales-based payments are variable payments tied to performance and are excluded from the initial measurement of the lease liability under ASC 842; they are recognized in profit or loss when incurred, so they do not increase the initial liability.
Why not D: Although the maintenance charges are fixed in amount, they are separately stated nonlease components. Birch did not elect the practical expedient to combine lease and nonlease components, so those maintenance payments are not included in the lease liability at commencement.
Common questions
Do I include CPI increases I expect after commencement in the initial lease liability?
No. Include CPI-linked payments measured using the CPI in effect at commencement. Later CPI changes are recognized when they occur unless a remeasurement trigger applies.
How do residual value guarantees affect the initial lease liability?
Include the amount that is probable of being owed under the guarantee at commencement. Do not include the contractual maximum if it exceeds the probable amount.
Do payments made at or before commencement go into the lease liability?
No. The lease liability includes only unpaid amounts. Payments at or before commencement increase the right-of-use asset and are excluded from the liability.
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