Occupancy Agreement vs Lease: Why the Label Does Not Decide It

In the occupancy agreement vs lease question, the title on the contract does not decide the accounting. Under ASC 842-10-15-3, a contract is a lease when it conveys the right to control the use of an identified asset for a period of time. That right must come in exchange for consideration.

An occupancy agreement, license, tenancy agreement or coworking membership that meets that test is a lease on your books. One that fails it is not a lease, whatever it is called. It is accounted for under other guidance, typically as a service.

This page works through the test for space arrangements and applies it to four common ones in a decision matrix. It is written for private companies applying ASC 842.

Does the name on the contract change the ASC 842 answer?

No. ASC 842-10-15-2 requires you to decide at contract inception whether a contract "is or contains a lease." The test reads the rights the contract conveys, not the heading on page one. Deloitte's Roadmap: Leasing, section 3.2, puts it plainly in its discussion of embedded leases (3.2.2): "not all leases will be labeled as such."

That matters on the books. A space agreement that is a lease and is not short-term puts a right-of-use (ROU) asset and a lease liability on the balance sheet. Booked as a service, the same agreement shows only monthly expense. Misread the label and the balance sheet is wrong.

Landlords and operators choose labels for legal reasons. A label can affect how a party ends the arrangement or which landlord-tenant rules apply. Those are questions for counsel. This page addresses only the accounting.

What four questions decide whether an occupancy agreement is a lease?

ASC 842-10-15-4 says you assess control "throughout the period of use." Put together with the identified-asset paragraphs, that gives four questions. A "no" to any one of them ends the analysis: no lease. One exception: a contract that states only an amount of space goes on to question 2, because the Codification's Example 2 decides that case on substitution (ASC 842-10-55-54).

1. Is the space identified? Under ASC 842-10-15-9, an asset is typically identified by being explicitly specified in the contract, such as Suite 410. ASC 842-10-15-16 lets a portion of a building qualify if it is physically distinct, like a floor.
2. Is the space free of a substantive substitution right? Under ASC 842-10-15-10, a substitution right defeats the identified asset only if it is substantive. The supplier must have the practical ability to substitute throughout the period of use and must benefit economically from doing so.
3. Do you get substantially all the economic benefits? ASC 842-10-15-17 gives exclusive use of the asset as one example of how a customer meets this.
4. Do you direct how and for what purpose the space is used? ASC 842-10-15-20 covers this right. For space, KPMG's Handbook: Leases, paragraph 3.3.190, gives the example of deciding how leased retail space is used.

Two rules help you with question 2. Under ASC 842-10-15-15, if you cannot readily tell whether a substitution right is substantive, you presume it is not. And PwC's Leases guide, section 2.3, notes that "a substitution right in a contract that allows substitution only with customer approval is not considered substantive."

Decision matrix: four space arrangements tested against ASC 842

Here are the inputs. Each arrangement is for a private company customer. Each is for office or retail space, and each charges a fee for the space.

• A. Floating coworking membership. Month-to-month, for "a desk in the open area." The operator assigns any open desk each day. The center has many open desks, and moving a member costs the operator almost nothing.
• B. Dedicated-suite membership. 24 months, for Suite 410, a lockable office with its own door. The operator may relocate the member only with the member's written approval. The member decides who works there and when.
• C. Kiosk license. Three years, for a stated amount of floor space anywhere in a mall's common areas. The operator can move the kiosk at any time. The kiosk is the customer's own, on casters, and the operator moves tenants to make better use of the space.
• D. Temporary occupancy agreement. Four months, for Suite 200, while the customer's main space is built out. Exclusive use, customer's own staff, a fee of $6,000 a month. No renewal or purchase option.

For arrangement D, the arithmetic is simple. Four months at $6,000 is $24,000 in total. With the short-term election, lease cost is $24,000 ÷ 4 = $6,000 a month, straight-line, with no ROU asset or liability.

Neither the word "membership" nor a fee that also covers cleaning, internet and reception stops it being a lease. Once a contract contains a lease, ASC 842-10-15-28 has you identify the separate lease components. The Codification's Example 4 makes a related point: the owner's cleaning and security services do not give it the right to direct how the space is used (ASC 842-10-55-71).

On the books, at commencement the member records an ROU asset and a lease liability (ASC 842-20-25-1). The liability is the present value of the fixed payments allocated to the suite (ASC 842-20-30-1).

Cleaning, internet and reception are nonlease components, separated unless the member elects, by class of asset, to combine them with the suite as one lease component (ASC 842-10-15-37). If that election is made, the whole fixed fee is included. See our guide to identifying embedded leases.

Arrangement A applies the same reasoning as the Codification's airport example, discussed next. The ASC 842 examples do not address coworking directly. If your membership names a desk, bars the operator from moving you, or the center has no other desks, run the test again.

License agreement vs lease: when does a right to occupy fail the test?

A license fails when the owner keeps a substantive right to move you. The clearest illustration is the Codification's Example 2, at ASC 842-10-55-52 through 55-54. A coffee company contracts for space at an airport for three years. The airport can change the location at any time, and the coffee company's kiosk "can be moved easily."

The example concludes that "the contract does not contain a lease." The amount of space is specified, but the location is not. The airport has the practical ability to move the kiosk, and it benefits by making "the most effective use of the space." Arrangement C mirrors the Codification's Example 2.

Name the unit and make relocation costly for the owner, and the answer flips. In Example 4 (ASC 842-10-55-63 through 55-71), a retailer contracts for Retail Unit A for five years. The owner can relocate it, but must pay the move and provide a similar unit, and benefits only if a major new tenant arrives, which is not likely at inception. The substitution right is not substantive, so the contract contains a lease.

The lesson for a controller is to read the relocation clause, not the title. Ask three things: can the owner move us without our approval, does it have other space ready, and would moving us cost it less than it gains? Only if all three answers are yes is the owner's right substantive, and only then does it defeat an otherwise identified space (ASC 842-10-15-10). If you cannot tell, presume the right is not substantive (ASC 842-10-15-15).

Tenancy agreement vs lease: does the legal label matter at all?

For the accounting, no. Take a tenancy agreement for a specified unit that you occupy exclusively and run as you choose. It meets ASC 842-10-15-3 the same way a document titled "Lease" does. The measurement that follows is the same too.

For the law, it may. Tenancy, license and occupancy labels can carry different rights under state landlord-tenant rules. Those rights can change your exit options, and exit options can change the lease term you measure. So the legal reading still feeds the numbers, but through the lease term, not through the label.

One term rule is worth knowing here. Under ASC 842-10-55-23, a contract stops being enforceable when both parties can terminate it without the other's permission and with no more than an insignificant penalty. A month-to-month agreement either side can end on short notice may have a very short enforceable period. For space in hotels and resorts, see our hospitality lease analysis.

What if the occupancy agreement runs 12 months or less?

It can still be a lease and still stay off the balance sheet. The ASC 842 Master Glossary defines a short-term lease as one that, at the commencement date, has "a lease term of 12 months or less." It also must not include a purchase option the lessee is reasonably certain to exercise.

ASC 842-20-25-2 lets a lessee elect, by class of underlying asset, not to recognize ROU assets and lease liabilities for short-term leases. Lease payments are expensed straight-line over the lease term. Arrangement D fits here. Our page on short-term leases and the practical expedient covers when the election is lost.

Watch one trap with temporary space. If the "temporary" agreement is really early access to the same premises under the main lease, it is not a separate short-term lease. Under ASC 842-10-55-19, taking possession to build out can be the commencement date of the main lease. See lease inception vs the commencement date, and our broader page on what constitutes a lease.

Frequently asked questions

Is a coworking membership a lease under ASC 842?

A floating or hot-desk membership usually is not a lease, applying the reasoning of the Codification's airport concession example (ASC 842-10-55-52 through 55-54). The operator can move you to any open desk at little cost and benefits from doing so. So its substitution right is substantive (ASC 842-10-15-10). A membership for a named, lockable suite that the operator cannot change without your approval usually is a lease (ASC 842-10-15-3 and 15-4).

Does a month-to-month occupancy agreement need ROU accounting?

Often not, if you have made the short-term election. Under ASC 842-10-55-23, a lease is no longer enforceable once both parties can end it without the other's permission and with no more than an insignificant penalty. So the enforceable period of a month-to-month agreement may be a month.

The lease term also includes renewal periods you are reasonably certain to use (ASC 842-10-30-1). KPMG's Handbook: Leases (paragraph 5.3.130) notes that a short noncancellable period makes renewals more likely to be reasonably certain. If the lease term is still 12 months or less, ASC 842-20-25-2 lets you expense it straight-line instead of recognizing an ROU asset and lease liability.

Is a four-month temporary occupancy agreement on the balance sheet?

Usually not, if you have made the short-term election. The arrangement is still a lease if it meets ASC 842-10-15-3. But a lease term of 12 months or less with no purchase option you are reasonably certain to exercise is a short-term lease. Under ASC 842-20-25-2 you can expense it straight-line instead of recognizing a right-of-use asset and lease liability.

Sources and further reading

• ASC 842-10-15-2 through 15-4 — identifying a lease and the right to control the use of an identified asset.
• ASC 842-10-15-9, 15-10, 15-15 and 15-16 — identified assets, substantive substitution rights and portions of assets.
• ASC 842-10-15-17 and 15-20 — economic benefits and the right to direct the use.
• ASC 842-10-15-28 — identifying separate lease components.
• ASC 842-10-55-52 through 55-54 (Example 2, concession space) and 55-63 through 55-71 (Example 4, retail unit).
• ASC 842-10-55-19 and 55-23 — commencement during build-out; the enforceable period.
• ASC 842-10-30-1 — the lease term, including renewal periods the lessee is reasonably certain to exercise.
• ASC 842 Master Glossary, Short-Term Lease; ASC 842-20-25-2 — the short-term lease election.
• Deloitte Roadmap: Leasing, section 3.2, Definition of a lease.
• Deloitte Roadmap: Leasing, section 3.3, Identified asset.
• PwC Leases guide, section 2.3, Definition of a lease.
• KPMG Handbook: Leases, chapter 3, Definition of a lease.

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