Combining Lease Contracts Under ASC 842

Combining lease contracts under ASC 842 turns on one paragraph, 842-10-25-19. Under ASC 842-10-25-19, contracts signed at or near the same time with the same counterparty (or its related parties), at least one of which is or contains a lease, must be combined if any one of three criteria is met.

The three criteria are short. The package was negotiated with one commercial objective. The price in one contract depends on the other. Or the rights of use together form a single lease component.

Once combined, you stop accounting for the paper and start accounting for the deal. You pool the price of every contract and split it again. That can move the lease liability, the lease cost and even the class of the lease. The signed papers no longer tell you the answer.

When do you have to combine contracts under ASC 842?

The test in ASC 842-10-25-19 has two layers. First come three threshold conditions, and all of them must hold:

• At least one of the contracts is or contains a lease.
• The contracts were entered into at or near the same time.
• The counterparty is the same entity, or a related party of it.

Then come the three criteria. Meeting any single one is enough to combine:

• One package, one objective. The contracts were negotiated as a package with the same commercial objective.
• Linked pricing. The consideration in one contract depends on the price or performance of the other.
• One lease component. The rights of use in the contracts, or some of them, are a single lease component under 842-10-15-28.

The third criterion borrows the component test. Under 842-10-15-28, a right of use is a separate lease component only if the lessee can benefit from it on its own or with readily available resources. It also must not be highly dependent on or highly interrelated with the other rights of use in the contract. A crane leased under one contract and its specialized boom under another will often fail that test and land in one component.

Why does the rule exist? Without it, price could shift between documents. A cheap lease beside a costly service contract would understate the lease liability.

The combination rule closes that gap. It is also deliberately close to the revenue standard's contract combination guidance, as KPMG's Handbook: Leases notes in section 4.6.

What counts as contracts entered into at or near the same time?

ASC 842 does not define the phrase. KPMG's Handbook, Question 4.6.10, says Topic 842 provides no bright line. It says an entity "should consider its customary business practices and other reasonable expectations."

KPMG's Handbook notes, in paragraph 4.6.40, that some entities have interpreted the phrase to mean "within 90 days or within the same fiscal quarter or reporting period" when applying it in other situations.

In practice, a controller sets a window as policy and then watches for exceptions. KPMG warns against ignoring two unusual, linked deals just because they fall outside the normal window. Its Question 4.6.20 adds that contracts signed by different divisions are still evaluated. Different teams may make the criteria less likely to be met.

On the books, this is a completeness control. Someone has to spot the service deal that was signed the same week as the lease. Our checklist for spotting embedded leases in service contracts covers the same review from the other direction.

Decision table: combine or keep the contracts separate?

Each row states one fact pattern, the paragraph that governs it and the outcome. Assume the threshold conditions hold unless the row says otherwise.

What does combining do to the lease liability and lease cost?

Combining changes the unit of account, not the measurement rules. You pool the price and split it again across the components. For a lessee, 842-10-15-33 requires allocation on a relative standalone price basis, unless the lessee elects the practical expedient in 842-10-15-37.

Here is a worked example with every input stated. A lessee signs two contracts with one vendor in the same week:

• Equipment lease: $4,000 a month for 36 months.
• Maintenance agreement: $500 a month for 36 months.
• Observable standalone price of the lease: $4,800 a month.
• Observable standalone price of the maintenance: $300 a month.

The lease is priced $800 below its standalone price. The maintenance is priced $200 above. The vendor priced the lease below market because it expects to recover the difference through the maintenance fee.

That linkage means 842-10-25-19(b) requires combination. The math runs as follows.

The lease payment that feeds the liability is $4,235.29 a month, not the $4,000 on the lease contract. Under 842-20-30-1, the lease liability is the present value of the lease payments not yet paid at commencement. So if the first payment is made on the commencement date, it stays out of the liability. The $264.71 is maintenance expense as the work is done.

If the lessee has elected the 842-10-15-37 expedient for this class of equipment, the answer changes. The whole $4,500 is treated as a single lease component. The liability is then measured on $4,500 a month, and no separate maintenance expense is recorded. Our page on lease and nonlease components in one contract walks through that election.

Classification follows the combined result too.

Under 842-10-25-1, each separate lease component is classified at the commencement date. KPMG Handbook ¶5.4.40 notes that its lease payments might be an allocated amount. So the tests run on the allocated payments, not the stated ones. The criteria are covered in applying the right lease classification.

How do combined contracts and lease modifications interact?

The two rules answer different questions. Combination asks whether documents signed together are one deal. A modification is a later change to the terms that changes the scope of or the consideration for a lease, as the ASC 842 glossary defines it.

The dividing line is timing. A contract signed long after the original lease fails the at-or-near-the-same-time condition in 842-10-25-19.

If it changes scope or price, you run it through 842-10-25-8. That paragraph treats it as a separate contract only when it adds a right of use and the price rises commensurate with the standalone price. Otherwise the lessee remeasures the lease.

Our modification decision framework covers those steps.

The two can also meet. KPMG's Handbook, Question 6.7.30, discusses a lessee that terminates one lease and signs a new one in the same negotiation. In KPMG's view, the two actions are a single transaction under 842-10-25-19, however they are papered.

A separate question is what happens after inception. PwC's Leases guide (section 5.5.3) addresses contracts that were required to be combined at inception when one or more of them, but not all, are later terminated for a penalty. In PwC's view, the parties apply modification accounting to the continuing contracts, because the combined contract has not been terminated in full.

Separately, 842-10-15-36 requires a lessee to remeasure and reallocate the consideration when the contract is modified and the modification is not a separate contract. After a combination, that reallocation covers every component of the combined contract.

Where do combined contracts hide in a real portfolio?

They rarely announce themselves. Look in four places:

• Procurement bundles. Equipment, service and supply agreements signed in one purchasing cycle.
• Master agreements. A master lease plus schedules, where the commitment level decides the answer under 842-10-55-17 and 55-18.
• Side letters. Rent concessions or service promises papered outside the lease.
• IT deals. Hosting, hardware and support signed as separate orders. See IT and software contracts with hidden lease components.

An auditor will ask how you found them. A good answer has three parts:

• A policy window for at or near the same time.
• A counterparty match across the vendor master.
• A record of each conclusion and the criterion applied.

Frequently asked questions

Do all three criteria have to be met to combine contracts under ASC 842?

Any one of the three criteria is enough under ASC 842-10-25-19. The threshold conditions still apply first: same time, same counterparty or related parties, and at least one lease.

Does ASC 842 define at or near the same time?

No. Topic 842 gives no bright line. KPMG's Leases Handbook says to look to customary business practices. It notes that some entities, applying the same notion elsewhere, have interpreted it as within 90 days or the same fiscal quarter or reporting period.

Is a lease amendment signed two years later combined with the original lease?

No. A contract signed long after the original lease fails the at-or-near-the-same-time condition in ASC 842-10-25-19. If it changes the scope of or the consideration for the lease, it is a lease modification, accounted for under ASC 842-10-25-8 through 25-18.

Sources and further reading

• ASC 842-10-25-19 — the contract combination threshold and its three criteria.
• ASC 842-10-15-28 — identifying separate lease components.
• ASC 842-10-15-33, 842-10-15-36 and 842-10-15-37 — lessee allocation, reallocation, and the practical expedient not to separate nonlease components.
• ASC 842-10-25-1 and 842-10-25-8 — classification of each separate lease component, and modifications accounted for as a separate contract.
• ASC 842-10-55-17 and 842-10-55-18 — master lease agreements with and without a committed minimum.
• ASC 842-20-30-1 — initial measurement of the lease liability.
• KPMG Handbook: Leases — section 4.6, Questions 4.6.10 and 4.6.20, paragraph 4.6.40, Example 4.6.10, paragraph 5.4.40, and Question 6.7.30, "Terminating one lease and entering into another with the same lessor".
• PwC Leases guide, section 2.3, Definition of a lease — combining arrangements when assessing whether a contract contains a lease.
• PwC Leases guide, section 5.5, Accounting for a lease termination — section 5.5.3 on changes to contracts combined at inception.

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