FAR · Select transactions · 11 practice questions
ASC 842 Lease Term: Renewal Options and Reassessment
Include enforceable renewal periods when exercise is reasonably certain; external rent or CPI changes alone do not trigger reassessment. Compare the same lease as one fact changes to see when the term changes.
Try one first
Hint
Focus on what causes a lessee to revisit lease term under ASC 842: is it a routine calendar-date review, or a specific event that changes the option assessment?
Answer B. ASC 842 requires a lessee to reassess the lease term when a significant event or change in circumstances occurs that is within the lessee's control and affects whether the lessee is reasonably certain to exercise an option. Approving and installing major tenant improvements that only provide significant benefit if the lessee remains for the renewal period is such a triggering event, so Delta must reassess in Year 2. Delta does not need to wait for formal exercise or a contract modification.
Why not A: This is tempting because formal notice confirms the decision, but ASC 842 requires reassessment when a triggering event within the lessee's control changes the reasonable-certainty analysis, which occurs earlier than formal exercise here.
Why not C: Candidates who focus on lease modifications may believe remeasurement is tied to contract changes. However, lease-term reassessment can be required absent any contract modification if facts or circumstances change the option assessment.
Why not D: This overgeneralizes periodic review. ASC 842 ties reassessment to triggering events or changes in circumstances that affect the reasonably certain conclusion, not to a routine annual reassessment in the absence of such events.
Same scenario, one fact changes
Base case
Delta leases store space for five noncancelable years with an enforceable five-year renewal option and annual CPI-based rent adjustments. At commencement, renewal is not reasonably certain. In Year 2, market rents and CPI rise. Delta takes no action affecting renewal. The lease is not modified.
Answer: Keep the five-year lease term. Neither external change alone triggers lease-term reassessment.
Market rent increases and CPI changes are external factors. With no reassessment trigger, Delta does not reconsider the renewal option merely because these factors change.
Before you open each one, predict the answer.
Change 1In Year 2, Delta installs significant location-specific improvements that make renewal reasonably certain.
Answer: Reassess when Delta installs the improvements. Include the renewal for a ten-year total term, remeasure at a revised discount rate, and adjust the right-of-use asset.
The improvements are a significant lessee-controlled event that changes renewal certainty. Formal exercise and a contract modification are not required.
Change 2Delta commits to a major location-specific build-out in Year 2, making renewal reasonably certain before construction starts.
Answer: Reassess at commitment, not construction completion. Include the renewal for a ten-year total term and remeasure using a revised discount rate.
The significant commitment itself changes the economic incentive to remain. Waiting for installation would delay reassessment beyond the triggering event.
Change 3At commencement, renewal is reasonably certain rather than not reasonably certain.
Answer: Use a ten-year lease term at commencement. The Year 2 external changes alone do not require reassessment.
Include the enforceable renewal when initially reasonably certain: five noncancelable years plus five renewal years. Actual exercise is not required.
Change 4In Year 2, Delta exercises the renewal option despite initially excluding it.
Answer: Reassess when Delta exercises the option. Include the renewal for a ten-year total term, remeasure at a revised discount rate, and adjust the right-of-use asset.
Actual exercise contrary to the prior assessment independently triggers reassessment. Significant improvements are not required for this trigger.
Key points
- Remember: Market rent or CPI changes alone do not trigger reassessment; significant lessee-controlled events directly affecting reasonable certainty do.
- Contractual events obliging exercise or nonexercise, and actual exercise or nonexercise contrary to the prior assessment, also trigger reassessment.
- Reasonably certain reflects economic incentives, not management's unsupported intention.
How the exam traps you
- Treating higher market rents or CPI changes alone as lease-term reassessment triggers. Separate external changes from events that require reassessment. External changes alone do not qualify.
- Waiting for formal exercise or a contract modification after a significant lessee-controlled commitment. Reassess when the significant commitment directly affects reasonable certainty, even before construction or formal exercise.
- Keeping the original discount rate when reassessment changes the lease term. Use a revised discount rate at reassessment and adjust the right-of-use asset for the liability change.
Now the same facts as questions
Each question changes one fact from the one before. Watch which change flips the answer.
Question 1
Answer A. Correct. Neither external change alone triggers lease-term reassessment.
Why not B: Market rent increases alone do not trigger reassessment.
Why not C: A CPI change alone does not require lease liability remeasurement under ASC 842.
Why not D: Routine reporting dates do not automatically trigger lease-term reassessment.
Question 2
Answer C. Correct. Include the renewal, remeasure at a revised rate, and adjust the right-of-use asset.
Why not A: The significant lessee-controlled event triggers reassessment before formal exercise.
Why not B: The revised lease term requires a discount rate determined at reassessment.
Why not D: Reassessing an existing renewal option does not create a separate lease.
Question 3
Answer B. Correct. The significant lessee-controlled commitment directly changes reasonable certainty.
Why not A: Completion is too late because the significant commitment already changes renewal certainty.
Why not C: Reassessment occurs at the triggering event, not automatically at year-end.
Why not D: Formal exercise is unnecessary once a significant lessee-controlled event changes reasonable certainty.
Question 4
Answer D. Correct. Five noncancelable years plus five renewal years gives a ten-year initial term.
Why not A: Reasonably certain renewal periods are included before actual exercise.
Why not B: There is no automatic annual reassessment requirement, and the renewal belongs in the initial term.
Why not C: A contract modification is not required to include an existing reasonably certain renewal.
Question 5
Answer C. Correct. Actual exercise contradicts the prior assessment, requiring reassessment and remeasurement at a revised rate.
Why not A: Actual exercise contrary to the prior assessment triggers reassessment without a modification.
Why not B: Significant improvements are one trigger, not a requirement for every reassessment.
Why not D: Reassessment occurs when Delta exercises the option, not when the renewal period begins.
Question 2
Hint
Start by identifying the lease term for measurement purposes, then separate included lease payments from amounts that are recognized only as incurred.
Answer D. Include fixed lease payments for the noncancelable term and any renewal periods the lessee is reasonably certain to exercise, plus amounts probable under a residual value guarantee. That is $40,000 × 3 = $120,000, plus $45,000 × 2 = $90,000, plus the $6,000 residual guarantee, for a total of $216,000. Usage-based variable payments and a purchase option not reasonably certain to be exercised are excluded from the initial lease liability.
Why not A: This equals the 3-year fixed payments ($120,000) plus the $6,000 residual guarantee but omits the 2-year renewal period that is reasonably certain to be exercised, so it understates the liability.
Why not B: This reflects adding expected usage-based variable payments (about $8,000/year) to the fixed amounts. Variable payments that depend on usage are recognized as incurred and are not included in the initial lease liability under the stated facts.
Why not C: This amount adds the $10,000 purchase price to the correct calculation; a purchase option is included only if the lessee is reasonably certain to exercise it, which is not the case here.
Question 3
Hint
Determine the lease term first, then decide which stated cash flows qualify as lease payments for the liability.
Answer B. The lease term is 6 years (4-year noncancelable term plus the 2-year renewal reasonably certain to be exercised). The lease liability includes the present value of the fixed lease payments for six years and the probable residual value guarantee, but excludes the separately stated maintenance (a nonlease component). Calculation: PV of rents = $40,000 × 5.0757 = $203,028; PV of residual guarantee = $6,000 × 0.7462 = $4,477; total = $203,028 + $4,477 = $207,505.
Why not A: This is the PV of only the 4-year noncancelable rent stream (40,000 × 3.5459). It omits the 2-year renewal period that must be included because Nori is reasonably certain to exercise the option.
Why not C: This includes the residual value guarantee but still uses only the 4-year term for the fixed rents (40,000 × 3.5459 plus 6,000 × 0.8227). Because the renewal option is reasonably certain, the lease liability must reflect six years of fixed rent.
Why not D: This amount reflects using the 6-year term and including the residual guarantee, but it also adds the $3,000 annual maintenance fee. The maintenance is a separately stated nonlease component and should be excluded when lease and nonlease components are accounted for separately.
Question 4
Hint
Ask whether the event is under Pine's control and whether it creates an economic commitment or asset-specific incentive to exercise the renewal.
Answer A. ASC 842 requires reassessment of the lease term only when a significant event or change in circumstances that is within the lessee's control affects whether it is reasonably certain to exercise an option. Making major, asset-specific leasehold improvements is a lessee-controlled commitment that creates a strong economic incentive to remain, so Pine must reassess the lease term when those improvements are made.
Why not B: This distractor tempts because higher market rents can change the economics of staying. It fails because market rent changes are external factors; ASC 842 focuses on lessee-controlled significant events or commitments, and the stem specifies the renewal pricing and option terms remain unchanged.
Why not C: This distractor tempts by suggesting improved prospects might increase the likelihood of renewal. It fails because subjective optimism, without asset-specific commitments or actions tying the lessee to the location, is not the type of lessee-controlled, significant change that triggers reassessment under ASC 842.
Why not D: This distractor tempts because reporting dates are natural checkpoints. It fails because mere indecision or the passage of a reporting date is not a significant event or change in circumstances; reassessment is required only when a specific lessee-controlled event occurs that affects the certainty of exercising the option.
Question 5
Hint
First determine the lease term used for classification. Then ask whether meeting one finance-lease criterion is enough, even if the others are not met.
Answer B. Under ASC 842, the lease term at commencement includes renewal periods the lessee is reasonably certain to exercise. Here the lease term is 9 years (6 + 3), which is a major part of the equipment's 10-year remaining economic life, so the lease meets the finance-lease (previously capital-lease) criterion. Meeting any one finance-lease criterion is sufficient even if the present value test (62% here) or other indicators are not met.
Why not A: This is tempting because candidates sometimes focus only on the noncancelable period. However, ASC 842 requires including renewal periods the lessee is reasonably certain to exercise when determining the lease term at commencement, so the 3-year option is included now.
Why not C: This distractor plays on the idea that all payments affect the PV test. In fact, variable payments based on future sales or usage (like a percentage of sales) are generally excluded from the initial measurement of the lease liability, so they don't push the present value to meet the 'substantially all' test here. More importantly, the lease is finance-classified because the lease term is a major part of the asset's life.
Why not D: This is tempting if a candidate recalls some finance-lease indicators and treats them as exhaustive. ASC 842 lists several alternative criteria; satisfying any one (such as the lease term being a major part of the asset's life) is sufficient for finance classification.
Question 6
Hint
Which of the 20X3 developments is an internal, lessee-controlled change that directly alters Orion's reasonable certainty about renewing the lease?
Answer B. ASC 842 requires a lessee to reassess the lease term when a significant event or a significant change in circumstances within the lessee's control affects whether it is reasonably certain to exercise an option. The substantial, location-specific leasehold improvements are an internal event that changes Orion's reasonable certainty; reassessment and inclusion of the renewal period should occur when that event happens. At the reassessment date Orion remeasures the lease liability using an updated discount rate and adjusts the ROU asset for the change in the liability.
Why not A: This is tempting because CPI changes affect required cash flows, but ASC 842 generally treats subsequent changes that result solely from a change in an index as variable lease payments recognized when they occur rather than as a trigger to remeasure the lease liability, absent another reassessment trigger or a lease modification.
Why not C: This is tempting because entities consider facts and circumstances at reporting dates, but an external market-rent increase is an external development and, by itself, does not satisfy ASC 842's reassessment trigger that requires a significant event or change within the lessee's control; here the internal improvements are the direct cause of the change in reasonable certainty.
Why not D: This reflects a legal-form intuition, but ASC 842 requires including optional periods once the lessee becomes reasonably certain they will be exercised; accounting reassessment and remeasurement occur when reasonable certainty changes, not only upon formal legal exercise.
Common questions
When must a lessee reassess the lease term under ASC 842?
Reassess for significant lessee-controlled changes directly affecting reasonable certainty, contractual events obliging exercise or nonexercise, or actual exercise or nonexercise contrary to the prior assessment. Market rent changes, CPI changes, and routine reporting dates alone do not trigger reassessment.
Can leasehold improvements make a renewal option reasonably certain?
Yes. Significant location-specific improvements can create an economic incentive to renew, even at market rent; a significant commitment that changes reasonable certainty triggers reassessment without waiting for formal exercise.
What discount rate is used when reassessment changes the lease term?
Remeasure the lease liability using a revised discount rate determined at the reassessment date. Make a corresponding adjustment to the right-of-use asset.
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