Spotting Embedded Leases in Contracts

It isn’t always easy to identify when you have a lease. Often, leases are embedded into other contracts. Consider the following example:

A manufacturing entity contracts with a distribution center to prep and ship one of its products. Packaging the product requires specialized equipment, which the distribution center builds and uses exclusively for the manufacturer. In this scenario, the contract between the manufacturer and the distributor likely has a lease component. When accounting for this contract, the manufacturer should identify how much of the contract price represents their right to use the packaging equipment and record that amount as a lease on their balance sheet.

5 Questions to Ask

Here are five questions to ask yourself to help you spot an embedded lease.

• Does the contract require an asset to be built or customized for you?
• Can you dictate how or when the asset is used?
• Are you the only customer to use the asset?
• When your contract ends, will the other party retire the equipment?
• Is a specific asset listed in the contract?

If you answered yes to any of these questions, you likely have an embedded lease.

Embedded leases can get confusing when it comes time to account for them. We are here to help. Reach out to our professionals to help you determine how your leases need to be accounted for according to the new lease standards.