What Is a Synthetic Lease? How ASC 842 Classifies and Measures One
What is a synthetic lease? It is typically a financing built in the form of a lease. A lessor entity funds the asset. The lessee pays rent, holds an option to buy the asset, and guarantees part of its value at the end of the term.
ASC 842 does not define the term; it is a market and structuring term. ASC 842 has no special model for it, so the general lease rules apply.
That changes the old result. At the start of a lease, ASC 842-20-25-1 has the lessee book "a right-of-use asset and a lease liability." That is true for operating leases too. The off-balance-sheet result these deals were often described as delivering is gone.
For the general model, see lease accounting explained. This page covers how the features of a synthetic lease run through it.
What makes a lease "synthetic"?
The term describes a structure, and the details vary by deal. A typical one has four parts:
- A lessor entity, often set up for the deal, borrows to buy or build the asset.
- The lessee leases the asset for a set term.
- The lessee holds a purchase option at the end.
- The lessee guarantees the lessor some or all of the asset's value if the asset is sold instead.
On the books, the deal was often described as aiming to be an operating lease. That is where its off-the-books name came from.
The deal can start before the asset exists, with the lessor paying for the build. The KPMG Handbook: Leases, Question 5.4.111, says single-asset leasing vehicles "are frequently used in capital-intensive arrangements." Its examples include data centers.
How does synthetic lease accounting work for the lessee?
The lessee runs the same steps as for any lease. It confirms a lease exists, sets the lease term, measures the lease payments and classifies the lease. Two features need care: the purchase option and the residual value guarantee.
The purchase option counts only when the lessee is reasonably certain to use it. Then ASC 842-10-30-5(c) includes "the exercise price of an option to purchase the underlying asset if the lessee is reasonably certain to exercise that option." To judge that, look at the factors in ASC 842-10-55-26: "contract-based, asset-based, market-based, and entity-based factors."
The guarantee goes into the lease payments at a lower figure than you might expect. For a lessee, ASC 842-10-30-5(f) includes only "amounts probable of being owed by the lessee under residual value guarantees." Deloitte's Roadmap: Leases, section 6.7 notes that many real estate assets "are expected to hold their value over the lease term." So the probable amounts "may be nominal," and the lease liability is then mostly the rent.
Two other items show up in these deals. ASC 842-10-30-5(e) includes fees paid to the owners of a special-purpose entity "for structuring the transaction." The same paragraph keeps those fees out of the asset's fair value for test (d). And ASC 842-10-30-6(b) excludes "any guarantee by the lessee of the lessor's debt" from lease payments.
The numbers can move later. ASC 842-10-35-4(c) requires the lessee to remeasure the lease payments when its view of the purchase option changes. The same applies when the amount it will probably owe under the guarantee changes. So if the asset's expected value falls, the lease liability can rise mid-term.
How is a synthetic lease classified under ASC 842?
Classification uses the five criteria in ASC 842-10-25-2. A lessee classifies the lease as a finance lease if any one is met at commencement. If none is met, ASC 842-10-25-3 makes it an operating lease. The ASC 842 lease classification page walks through each test.
The guarantee is where synthetic leases part ways with plain rent deals. ASC 842-10-25-2(d) adds two amounts and takes the present value of the sum. One is the lease payments. The other is "any residual value guaranteed by the lessee that is not already reflected in the lease payments."
That present value is then tested against "substantially all" of the asset's fair value. So the test takes in the discounted guarantee, not just the probable amount.
Deloitte reads it the same way. Its Roadmap: Leases, section 6.7 puts it plainly. "ASC 842-10-25-2(d) requires a lessee to include the full amount of any residual value guarantee, regardless of whether it is probable that the amount will be owed." Section 8.3.3.6 says to include it "at the maximum required deficiency that a lessee may be required to pay."
ASC 842 sets no separate rule for synthetic leases. The table below applies the general tests to the usual features. Your own contract's terms decide the answer.
Which ASC 842 rules does each synthetic lease feature trigger?
This table maps each usual feature to the test or rule it feeds.
| Feature | Test or rule it feeds | Paragraph | What to check |
|---|---|---|---|
| Title passes at the end | Transfer of ownership | 842-10-25-2(a) | Is the transfer automatic? A fee the lessee may skip makes it an option (842-10-55-6). |
| Purchase option | Option the lessee is reasonably certain to use | 842-10-25-2(b); 842-10-55-26 | Price against expected value, and how much the lessee needs the asset |
| Option price | Lease payments, if the test above is met | 842-10-30-5(c) | Same facts as test (b) |
| Lease term | Major part of the asset's remaining life | 842-10-25-2(c) | Term, with renewals the lessee is reasonably certain to use |
| Guarantee, full amount | Present value test against fair value | 842-10-25-2(d) | The most the lessee could have to pay |
| Guarantee, probable amount | Lease payments in the liability | 842-10-30-5(f); 842-10-35-4(c) | The amount it will probably owe, updated as that changes |
| Fees to the entity's owners | Lease payments, but not fair value in test (d) | 842-10-30-5(e) | Fees paid for setting up the deal |
| Guarantee of the lessor's debt | Left out of lease payments | 842-10-30-6(b) | Does it run to the lender or to the asset's value? |
| Asset built to the lessee's design | No other use to the lessor | 842-10-25-2(e) | Could the lessor lease or sell it to someone else? |
| Lessee role in the build | Control before commencement | 842-40-55-5 | Rights to buy during the build, or hold of the land |
Here is how the guarantee rows split. This is an illustration of inputs only, with figures chosen for the example; it does not run the full test. Say the lessee guarantees any shortfall below $10,000,000 on sale, capped at $8,500,000. It expects the asset to be worth $10,500,000 at the end.
The classification test includes the present value of the $8,500,000 maximum, discounted from the end of the term. The lease liability includes $0, because no payment is probable. One guarantee, two different inputs.
What if the lessee controls the asset during construction?
Many synthetic leases pay for a building before it exists. ASC 842-40-55-5 asks if the lessee "controls the underlying asset being constructed before the commencement date." If it does, the deal falls under the sale and leaseback rules in Subtopic 842-40.
The paragraph lists signs of control. One is a lessee right "to obtain the partially constructed underlying asset at any point during the construction period." Another is owning, controlling or leasing the land, unless the lessee leases or subleases it to the lessor for substantially all of the building's life (ASC 842-40-55-5(d)–(e)). Our built-to-suit lease page walks through the full list.
In KPMG's reading, a lessee that controls the asset during construction is its accounting owner while it is built (KPMG Handbook: Leases, section 9.4). Whether it can later remove the asset turns on whether the transfer qualifies as a sale under ASC 842-40-25-1. Our page on sale-leaseback gain recognition under ASC 842 covers that test.
Synthetic lease vs operating lease: what changes on the books?
Under ASC 842-10-25-3, a synthetic lease is still an operating lease if no criterion in ASC 842-10-25-2 is met. In practice, it will not be off the balance sheet. Both classes carry a right-of-use asset and a lease liability.
The difference shows up in the income statement. For an operating lease, ASC 842-20-25-6 calls for "a single lease cost," most often spread straight-line. For a finance lease, ASC 842-20-25-5 calls for two lines: amortization of the right-of-use asset and interest on the lease liability. See operating vs. finance lease journal entries for the entries side by side.
The balance sheet can still look lighter than the deal. Deloitte's section 6.7 looks at deals that put much of what the lessee owes into a guarantee. Such deals "could therefore result in ROU assets and lease liabilities that are significantly lower" than fixed-rent deals. Deloitte adds that they "may continue to yield favorable accounting results (e.g., reduced leverage) under ASC 842."
Tax treatment follows tax rules and is outside this page.
Does the lessee also need to consider consolidating the lessor?
It may. The lessor in these deals is often an entity set up to hold one asset. That raises a question under Topic 810 as well as the lease question.
The KPMG Handbook: Leases takes this up in Question 5.4.111. KPMG says that a potential lessee "evaluates the arrangement under the consolidation guidance in Topic 810 in addition to applying the lease accounting guidance in Topic 842." It adds that residual value guarantees and fixed-price purchase options "may constitute variable interests."
KPMG also says the result of that work "will determine whether lease accounting is reflected" in the lessee's books. The consolidation work itself is outside this page.
Frequently asked questions
Does a synthetic lease stay off the balance sheet under ASC 842?
No. ASC 842-20-25-1 requires a lessee to recognize a right-of-use asset and a lease liability at the commencement date, for operating and finance leases alike. Classification now changes how the cost runs through the income statement, not whether the lease is on the balance sheet.
Why does a residual value guarantee count differently for classification and measurement?
The two rules ask different questions. The classification test in ASC 842-10-25-2(d) includes the present value of the full guaranteed amount, so it measures how much risk the lessee has taken on. The lease liability under ASC 842-10-30-5(f) includes only the amount probable of being owed, so it measures the expected cash outflow.
Does ASC 842 define a synthetic lease?
No. ASC 842 does not define the term; it is a market and structuring term. The accounting follows from the contract's terms and the general lease guidance, not from a separate synthetic lease model.
Sources and further reading
- KPMG Handbook: Leases, which reproduces ASC 842-10-25-2, 842-10-30-5, 842-10-35-4, 842-20-25-1 and 842-40-55-5, with section 9.4 on lessee control before commencement and Question 5.4.111 on single-asset leasing vehicles.
- Deloitte Roadmap: Leases, section 6.7, Amounts That It Is Probable That the Lessee Will Owe Under a Residual Value Guarantee.
- Deloitte Roadmap: Leases, section 8.3, Lease Classification (lessee).
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