Associate Safety Professional (ASP)

Correct: Under both ASC 842 and IFRS 16, the initial measurement of the ROU asset is derived from the lease liability. It specifically includes the initial lease liability amount, any payments made to the lessor before or at commencement (prepaid rent), and initial direct costs (incremental costs that would not have been incurred if the lease had not been obtained), while subtracting any lease incentives received from the lessor.

Incorrect: Excluding initial direct costs or prepayments is incorrect because these are required components of the ROU asset under the new standards. Using the fair value of the underlying asset is not the standard lessee ROU measurement, which is based on the present value of lease payments. Using undiscounted payments ignores the fundamental requirement to present the lease liability at present value, which forms the basis of the ROU asset.

Takeaway: The ROU asset is a capitalized value comprising the lease liability, prepayments, and direct costs, net of incentives.

Correct: Under ASC 842, when a lease modification occurs that results in the lease no longer qualifying for the short-term lease exemption (i.e., the lease term becomes greater than 12 months), the lessee must recognize a right-of-use (ROU) asset and a lease liability. This recognition is performed as of the effective date of the modification, using the remaining lease payments and the appropriate discount rate at that time.

Incorrect: Option b is incorrect because the short-term exemption is based on the total lease term of the modified contract, not just the remaining term at the time of the amendment. Option c is incorrect because lease modifications are generally accounted for prospectively from the modification date rather than through retrospective restatement of prior periods. Option d is incorrect because a modification does not automatically dictate a finance lease classification; the lease must still be evaluated against the five classification criteria (such as transfer of ownership or bargain purchase options) to determine if it is operating or finance.

Takeaway: A lease modification that extends the total term beyond 12 months requires the lessee to terminate the short-term exemption and recognize the lease on the balance sheet prospectively.

Correct: Under IFRS 16, while an exemption exists for low-value assets, the application of this exemption must not result in a material misstatement of the financial statements. If the aggregate value of excluded leases exceeds the organization’s established risk tolerance (in this case, 5% of liabilities), the threshold must be adjusted downward. This ensures that the financial reporting remains aligned with the board’s risk appetite for accuracy and compliance.

Incorrect: Increasing disclosures does not rectify the breach of risk tolerance regarding the recognition of liabilities on the balance sheet. Amending the risk tolerance framework simply to accommodate a policy breach undermines the governance structure and does not address the underlying reporting risk. Transferring responsibility to a non-accounting department like IT procurement is inappropriate as it removes necessary financial oversight and does not solve the compliance issue regarding lease recognition standards.

Takeaway: Lease accounting thresholds for low-value assets must be calibrated so that the aggregate effect of excluded leases does not exceed the organization’s defined risk tolerance for financial reporting errors.

Correct: Under ASC 842, if a lessor determines that the collectibility of lease payments is not probable, the lessor must limit the lease income recognized to the lesser of the income that would be recognized on a straight-line basis or the lease payments actually received (cash basis). Therefore, the first step in addressing a deficiency related to a bankrupt tenant is to perform a collectibility assessment to determine if the accrual-based recognition remains appropriate.

Incorrect: Terminating the lease immediately is incorrect because bankruptcy law generally stays such actions and allows the debtor to assume or reject the lease. Adjusting the discount rate for an existing lease due to changes in credit risk is not permitted under ASC 842, as the rate is typically fixed at commencement unless a modification occurs. Reclassifying the lease from operating to sales-type is also prohibited because lease classification is determined at the commencement date and is not revisited solely due to changes in the lessee’s creditworthiness.

Takeaway: When a lessee’s creditworthiness deteriorates significantly, such as in bankruptcy, the lessor must evaluate collectibility to determine if lease income should be recognized on a cash basis under ASC 842.

Correct: According to ASC 860 (Transfers and Servicing), a transfer of financial assets is only accounted for as a sale if the transferor surrenders control. If the transferor maintains effective control, such as through a repurchase agreement, the transaction fails the ‘true sale’ criteria. In this scenario, the transferor must continue to report the leased assets on its balance sheet and recognize the proceeds received as a secured borrowing (a financial liability).

Incorrect: Treating the transaction as a derecognition event is incorrect because the retention of control via a repurchase agreement prevents the transaction from being classified as a sale. Classifying the transaction as a lease modification is incorrect because a securitization involves the transfer of financial interests to a third party (SPE) and does not change the contractual terms between the original lessor and lessee. A sale-leaseback arrangement is a specific accounting model under ASC 842 for selling a physical asset and leasing it back, which does not apply to the securitization of existing lease receivables where control is not surrendered.

Takeaway: Securitization transactions that fail to meet ‘true sale’ criteria due to retained control must be accounted for as secured borrowings rather than asset derecognition.

Correct: Under ASC 842, when a lease modification occurs that does not result in a separate contract (such as extending the term of an existing asset), the lessee is required to remeasure the lease liability. This remeasurement must use a revised discount rate (the incremental borrowing rate) as of the effective date of the modification. A corresponding adjustment is then made to the right-of-use (ROU) asset to reflect the change in the liability.

Incorrect: Accounting for a modification as a separate contract is only appropriate if the modification grants the lessee an additional right of use (e.g., additional equipment or space) at a price that is commensurate with the standalone price for that additional use. Recognizing an immediate impairment loss is incorrect because a modification to terms and payments is a remeasurement event, not necessarily an impairment event under ASC 360. Treating the extension as a contingent rental expense is prohibited under ASC 842, which requires all fixed payments over the enforceable term to be recognized as part of the lease liability.

Takeaway: Lease modifications involving term extensions and payment changes require a remeasurement of the lease liability using a current discount rate and a corresponding adjustment to the ROU asset.

Correct: Under ASC 842 and IFRS 16, variable lease payments that do not depend on an index or a rate (such as those triggered by specific events like reactive maintenance or usage) are excluded from the measurement of the lease liability and the Right-of-Use (ROU) asset. These payments are recognized as an expense in the period in which the event or condition that triggers the payment occurs.

Incorrect: Capitalizing estimated costs based on historical averages is incorrect because only variable payments based on an index or rate are included in the initial measurement of the ROU asset. Including projected costs in the lease liability is incorrect as variable payments not tied to an index/rate do not meet the definition of lease payments for liability calculation. Treating maintenance as a lease modification is incorrect because a modification involves a change in the scope or consideration of a contract that was not part of the original terms, whereas reactive maintenance is a variable expense or a non-lease component.

Takeaway: Variable lease payments not tied to an index or rate, such as reactive maintenance, must be expensed as incurred rather than capitalized into the lease liability or ROU asset.

Correct: Under ASC 842, the recognition of lease liabilities on the balance sheet increases reported liabilities, which can negatively impact leverage ratios. However, the ROU asset is a non-monetary asset representing the right to use an underlying asset; it is not a liquid resource available to pay off debts. Therefore, a lessor must evaluate the lessee’s cash flow and debt-service coverage, acknowledging that the balance sheet now reflects long-term commitments that were previously disclosed only in footnotes.

Incorrect: Treating the ROU asset as a liquid asset is incorrect because it cannot be converted to cash to meet short-term obligations. Excluding lease liabilities from debt calculations is inappropriate for risk assessment as they represent firm legal obligations that impact a company’s financial flexibility. Assuming an improvement in debt-to-equity is generally incorrect; the addition of a new liability typically increases leverage, and any minor adjustments for initial direct costs do not fundamentally change the increased debt profile of the lessee.

Takeaway: ASC 842 requires analysts to recognize that while lease liabilities increase reported debt, the corresponding ROU assets do not improve liquidity, requiring a deeper focus on cash-flow-based coverage ratios.

Correct: Under ASC 842, a lease exists if a contract conveys the right to control the use of an identified asset for a period of time. Identifying embedded leases requires evaluating whether the supplier has substantive substitution rights and whether the customer directs the use of the asset. A cross-functional review ensures that the technical accounting criteria are applied to procurement activities that might otherwise be viewed strictly as service arrangements.

Incorrect: Restricting the definition to contracts with title transfer describes only one specific type of finance lease and ignores the broader definition of a lease under ASC 842. Automatically classifying all long-term service contracts as finance leases is incorrect because many may not meet the lease criteria at all, or may be operating leases. Using a high materiality threshold to exclude service contracts from the identification process violates the requirement to evaluate contracts for lease components regardless of their initial classification as services.

Takeaway: Effective lease identification controls must focus on the substantive criteria of asset identification and control rights rather than the legal form or title of the contract.

Correct: Under Section 365 of the Bankruptcy Code, a debtor-in-possession has the choice to assume or reject an unexpired lease. If the debtor chooses to assume the lease (continue the contract), they must take the contract ‘cum onere’ (with the burdens). This requires the debtor to cure any existing defaults (or provide a prompt cure) and provide ‘adequate assurance’ to the lessor that they will be able to fulfill future obligations under the lease terms.

Incorrect: The concept of ‘cherry-picking’ or selective assumption is prohibited; a lease must be assumed or rejected as a whole. Pre-petition arrears are not automatically waived; they must be cured if the lease is assumed. While ‘cramdown’ provisions exist for secured debts, they do not apply to ‘true leases’ where the lessor retains ownership; the debtor cannot unilaterally rewrite the lease into a secured loan to reduce the obligation to the asset’s fair market value.

Takeaway: To retain a lease in bankruptcy, a debtor must assume the contract in full, which requires curing all defaults and proving the ability to meet future obligations.