What Are Non-Lease Components Under ASC 842?

The accounting standard ASC 842 governs how companies report leases. Many contracts for assets like buildings or equipment bundle multiple charges into a single payment, which can include services and maintenance beyond just the right to use the asset. Under ASC 842, companies must distinguish between the core right to use an asset—the lease component—and any additional goods or services, known as non-lease components. This separation is required to ensure a company’s balance sheet accurately reflects its lease-related assets and liabilities.

Identifying Non-Lease Components in a Contract

Under ASC 842, a contract component is an item or activity that transfers a good or service to the lessee. The primary element is the lease component, which represents the right to use an identified asset for a period of time, such as an office space or vehicle. Payments for this component are for securing the use of that asset.

A non-lease component is a distinct good or service separate from the right to use the asset. These components transfer a benefit the lessee could theoretically procure from another vendor. Common examples include maintenance services for equipment, security for a building, or janitorial services for an office.

Some payments are not considered components because they do not transfer a good or service to the lessee. Payments to reimburse the lessor for property taxes or insurance on the asset are classified as non-components. These are costs of the lessor passed through to the lessee, rather than a service being provided.

The Lessee’s Practical Expedient Election

ASC 842 provides lessees with an accounting policy election known as a practical expedient. This option allows a lessee to not separate non-lease components from their associated lease components and instead account for the combined items as a single lease component. This election simplifies the accounting process by removing the need to perform a detailed allocation of payments.

A company must make this election by class of underlying asset, applying the policy consistently to all leases within a category like real estate or vehicles. It cannot be applied on a lease-by-lease basis. For example, a company electing this for its vehicle fleet must bundle non-lease components like maintenance with the lease for every vehicle lease.

Opting for this expedient directly impacts the balance sheet. Combining all payments into a single lease component makes the total lease payments higher than if they were separated. This results in a larger Right-of-Use (ROU) asset and a larger lease liability. This can impact financial metrics and debt covenants.

The decision to use the practical expedient involves a trade-off between simplicity and financial reporting impact. Companies choose it to avoid determining standalone prices and performing allocations. Others may avoid it because the inflated asset and liability figures could present a less favorable financial position.

Allocating Consideration and Separating Components

If a lessee forgoes the practical expedient, it must separate the components and allocate the total contract consideration between them. This allocation is based on the relative standalone prices of each component. The standalone price is what the lessor would charge for that component if sold separately.

Determining standalone prices is straightforward if the contract itemizes them or if observable market prices exist for similar goods or services. If no observable price is available, the lessee must estimate the price using all reasonably available information, which requires judgment and documentation.

After allocation, the accounting for each component diverges. The consideration for the lease component is used to calculate the ROU asset and lease liability recorded on the balance sheet. This amount is then recognized as a single lease expense over the lease term.

The consideration for non-lease components is accounted for separately. These costs are recognized as expenses when incurred or the service is received. This method results in a lower ROU asset and lease liability compared to using the practical expedient but requires a more complex analysis.

Lessor Accounting Requirements

The accounting requirements for lessors differ from those for lessees. Lessors do not have a broad practical expedient to combine components. The default requirement for a lessor is to separate the components in a contract and account for them individually.

To allocate contract consideration, lessors must apply the guidance in ASC 606, Revenue from Contracts with Customers. The lessor allocates payments to each component based on their relative standalone selling prices, similar to the method for lessees. This ensures revenue is recognized appropriately for each distinct good or service.

After allocation, the accounting follows different standards. The consideration for the lease component is accounted for as lease income under ASC 842. The consideration for non-lease components is recognized as revenue under ASC 606 as the service is performed.

A very limited practical expedient exists for lessors, but it is much more restrictive than the lessee’s option. It is only available if the timing and pattern of transfer for all components are the same and the lease is classified as an operating lease. Due to these constraints, most lessors must separate and allocate the components.