ASC 842 Finance vs. Operating Lease: Lessee Classification

Answer A. Sale-leasebacks of land follow the same ASC 842 framework as building/equipment sale-leasebacks. The leaseback is classified per standard criteria: land has indefinite useful life, so the 'major part of useful life' criterion is generally not met by any finite lease term, and there's no obvious 'substantially all of FV' threshold either since the land doesn't depreciate. Land leases that don't transfer ownership and don't satisfy other transfer-of-control criteria typically classify as OPERATING LEASES on the lessee side. Atlantic recognizes immediate gain on sale (assuming control transferred under ASC 606) and accounts for the operating leaseback with an ROU asset and lease liability at the present value of payments. Answer B is incorrect: ASC 842 does NOT prohibit sale-leasebacks of land. Land's non-depreciable nature affects classification but not the existence of the framework. Answer C is incorrect: land leases are typically OPERATING, not finance, because the indefinite-useful-life nature means finite lease terms rarely cover a 'major part' of useful life. Answer D is incorrect: ASC 605 was the old revenue standard (superseded by ASC 606). Sale-leasebacks are governed by ASC 842 with reference to ASC 606 for the sale test.

Answer D. Under ASC 842, a QUALIFYING sale-leaseback (where the sale qualifies under ASC 606 control-transfer principles) recognizes gain or loss IMMEDIATELY at the sale date, there is no gain deferral regardless of whether the leaseback is operating or finance. The leaseback is then accounted for under standard ASC 842 lessee rules based on its classification: (1) FINANCE LEASE (Quill's case): Record an ROU asset and lease liability at the present value of lease payments using the implicit rate or incremental borrowing rate. The ROU asset is amortized straight-line over the lease term (or shorter useful life if ownership transfers). The lease liability accrues interest at the implicit rate; payments split between interest expense and lease liability principal reduction. INCOME STATEMENT PATTERN: front-loaded expense (more interest in early years; declining as principal reduces). (2) OPERATING LEASE: Same balance sheet recognition (ROU asset + lease liability) but income statement is straight-line lease expense (effectively a single expense line spread evenly). Answer A is incorrect: classification depends on the lease terms (finance vs operating), not on Quill being the lessee. The question states finance lease applies. Answer B is incorrect: under current ASC 842, sale-leaseback gains are NOT deferred, that was the older ASC 840 framework. Current GAAP recognizes gain immediately for qualifying sale-leasebacks. Answer C is incorrect: ASC 842 brought leases on-balance-sheet; the executory-contract framework no longer applies for material leases.

Answer B. None of the finance-lease criteria are met (no transfer of ownership, no purchase option, the 3-year term is not a major part of the 30-year remaining life, PV of payments is not substantially all of fair value, and the asset is not specialized). Therefore the lease is classified as an operating lease. Under ASC 842, lessees recognize a right-of-use asset and a lease liability at commencement for operating leases unless the short-term lease exception applies (it does not here).

Why not A: This reflects the pre-ASC 842 off‑balance‑sheet treatment. Under current U.S. GAAP (ASC 842), operating leases generally require recognition of a right-of-use asset and a lease liability unless the lease is short-term.

Why not C: While ASC 842 requires balance-sheet recognition for most leases, classification as a finance lease requires meeting one of the finance-lease tests (ownership transfer, purchase option reasonably certain, term is major part of economic life, PV substantially all of fair value, or specialized asset). Those tests are not met here, so the lease is operating, not finance.

Why not D: The stem states Harlan has the right to control use of a specifically identified warehouse, which indicates a lease under ASC 842. Failing the finance-lease criteria simply results in operating-lease classification rather than converting the contract into a service arrangement.

Answer D. A lease is a finance lease for the lessee if any finance-lease criterion is met, and transfer of ownership by the end of the lease term is one such criterion. Therefore Kane's lease is a finance lease. For a finance lease the lessee presents interest expense on the lease liability separately from amortization (depreciation) of the right-of-use asset rather than a single straight-line lease expense.

Why not A: This is tempting because operating leases are presented as a single lease expense under ASC 842, but it is wrong here: transfer of ownership at term-end triggers finance-lease classification, so a single straight-line lease expense is not the correct presentation.

Why not B: This correctly identifies the classification but mistakes the income-statement pattern. Finance leases require separate interest on the liability and amortization of the ROU asset, not a single straight-line lease expense.

Why not C: This mixes two concepts. While lessees recognize a lease liability and ROU asset for both types of leases, only finance leases report separate interest and amortization; operating leases use a single lease expense pattern.

Answer A. Under ASC 842, a lessee classifies a lease as a finance lease only if at least one specific finance criterion is met (e.g., transfer of ownership, purchase option reasonably certain to be exercised, lease term is a major part of the asset's economic life, present value of payments is substantially all of fair value, or the asset has no alternative use to the lessor). Here none of those criteria are met: no transfer of ownership or likely purchase option, 4 of 12 years is not a major part of the economic life, the PV is only 60% (not substantially all), and the asset will have alternative use to the lessor. Therefore Park should classify the lease as an operating lease.

Why not B: Tempting because lessees recognize a right-of-use asset and lease liability for most leases, but recognition alone doesn't make a lease a finance lease; a specific finance criterion must be met, and none are met here.

Why not C: A short-term lease generally has a lease term of 12 months or less with no purchase option reasonably certain to be exercised; a 4-year lease does not qualify.

Why not D: A sales-type lease is a lessor classification. As the lessee, Park would classify the lease only as either operating or finance, so this option is not applicable.

Answer B. Under ASC 842, a sale-leaseback's leaseback portion is classified using the SAME 5 finance-lease criteria as any other lease. Hartford's leaseback fails ALL 5 criteria: (1) NO transfer of ownership (no transfer at end of term); (2) NO purchase option (none, let alone a 'reasonably certain to exercise' one); (3) Lease term (4 yrs) / useful life (8 yrs) = 50%, BELOW the 'major part' threshold (commonly 75%); (4) PV of payments at market rates < 'substantially all' of FV (commonly 90%); (5) Equipment is not specialized with no alternative use to lessor. None met → OPERATING LEASE. Hartford accounts for the operating leaseback with: ROU asset + lease liability on balance sheet at PV of lease payments; straight-line lease expense on the income statement (single expense pattern); cash payments classified as operating activities. Hartford recognizes IMMEDIATE GAIN on sale ($400K − carrying amount) per ASC 842 (no gain deferral). Answer A is incorrect: sale-leasebacks are NOT automatically finance leases. The leaseback's classification depends on the standard 5 criteria, not on the seller-lessee relationship. Answer C is incorrect: 'sales-type' is a LESSOR classification (the buyer-lessor's view in ASC 842), not a lessee classification. Hartford as lessee uses operating vs finance. Answer D is incorrect: ASC 842 always requires lease classification analysis; sale-leasebacks don't bypass it.