Memo

To: Auto Inc.

From: Cody Walkup

CC: File

Date: 9/28/2017

Re: New Leasing Standard

Facts
Per your request, we have considered your(Auto) agreements with Trans-Atlantic
(Atlantic) in order to determine whether the contracts contain an identified asset and whether
they convey the right to control the use of the identified asset. The relevant facts of the case are
as follows:

Sedan Contract
- Auto contracts Atlantic to ship its sedans to Europe.
- Atlantic has a fleet of 10 vessels with capacity for 2,000 vehicles.
- Sedan contract is five years in length.
- Auto has its own dedicated ship from Alantic’s fleet for sedan deliveries.
- Auto determines which ports receive shipments and the order of the deliveries.
- Auto has the option to send the ship below capacity. If below capacity Atlantic can’t use
excess capacity to ship other customer’s products.

Luxury Car Contract

- Auto contracts Atlantic to ship its luxury cars to Europe.
- Atlantic has a fleet of 10 vessels with capacity for 2,000 vehicles.
- The luxury car contract is five years in length.
- Atlantic is required to deliver shipments of Luxury Cars within five weeks of notification
from Auto.
- Atlantic picks the ship that will be used.
- Auto may provide 250 to 2,000 Luxury Cars in a single request; however, shipment is
usually under 500.
 - Atlantic has the option to use excess capacity to ship products of other customers.
- After notification, Atlantic picks when within the five-week period to ship the cars, as
well as the route.

Laws

Topic 842 applies to all leases and subleases and defines a lease as a “contract, or part of a
contract, that conveys the right to control the use of identified property, plant, or equipment (an
identified asset) for a period of time in exchange for consideration”.
In order to determine whether the new leasing standard has any impact on Auto’s shipping
arrangements, we need to figure out if the contracts contain a lease, which would fall under the
new Accounting Standard Update. According to 842-10-15-3, a contract contains a lease if the
contract conveys the right to control the use of identified property, plant, or equipment (an
identified asset) for a period of time in exchange for consideration. If further states that “a
period of time may be described in terms of the amount of use of an identified asset”.

Determining if there is an identified asset in the contract is normally the first step in determining
if the contract is or contains a lease. According to 842-10-15-9, an asset is usually identified by
being “explicitly specified” in a contract. Paragraph nine, also states that “an asset can also be
identified by being implicitly specified at the time the asset is made available for use by the
customer”.

Secondly, it needs to be determined if the contract transfers the right to control the use of the
asset that was previously identified. 842-10-15-4 states that “an entity shall assess whether,
throughout the period of use, the customer has both of the following: a) The right to obtain
substantially all of the economic benefits from use of the identified asset. b) The right to direct
the use of the identified asset”. The section also states that if the lessee has the right to control
the use of an identified asset for only a portion of the term of the contract, the contract contains a
lease for that portion of the term.

The capacity portion of the asset is considered an identified asset if it is physically distinct.
Paragraph 16 uses an example of a floor of a building or segment of a pipeline that connects a
single customer to a larger pipeline. It also states that a building or a segment of a pipeline that
connects a single customer to the larger pipeline). 842-10-15-16 states, “a capacity or other
portion of an asset that is not physically distinct is not an identified asset, unless it represents
substantially all of the capacity of the asset and thereby provides the customer with the right to
obtain substantially all of the economic benefits from use of the asset.” The example given was
that of a capacity portion of a fiber optic cable.
Topic 842 goes on to say that in order to control the use of an identified asset a customer or
lessee need to have the right to obtain the economic benefits from use of the asset during the
period of use. The example used in the paragraph was having exclusive use of the asset
throughout the period. 842-10-15-17 states that “a customer can obtain economic benefits from
use of an asset directly or indirectly in many ways, such as by using, holding, or subleasing the
asset. The economic benefits from use of an asset include its primary output and by-products and
other economic benefits from using the asset that could be realized from a commercial
transaction with a third party.”
When determining whether you have the right to obtain the economic benefits from use of an
asset during the period of use, you should only consider the economic benefits that occur during
the period or usage that’s define in the contract. 842-10-15-18 states that “When assessing the
right to obtain substantially all of the economic benefits from use of an asset, an entity shall
consider the economic benefits that result from use of the asset within the defined scope of a
customer’s right to use the asset in the contract”. One of the examples given is a contract that
limits the use a vehicle to a certain area during the use, which would limit the consideration of
economic benefits to only for use in the specified area.
In addition, in order to be considered a lease the customer should have the right to direct the use
of an identified asset during the time of use. 842-10-15-20 gives a couple examples of how a
customer can have the ability to direct the use of the identified asset. The first situation
paragraph 20 gives is “The customer has the right to direct how and for what purpose the asset is
used throughout the period of use”. The second situation is if “The relevant decisions about how
and for what purpose the asset is used are predetermined”. This predetermination of how and for
what purposes an asset is used can be made in multiple ways. Examples given include the design
of the asset or the contractual restrictions on the use of the asset.

Laws

Sedan Contract

In our opinion, Auto’s sedan contract with Atlantic does contain an identified asset.

- The MV Manhattan is dedicated to shipping Auto’s sedans for the term of the contract. It
is also “explicitly specified” in the contract.

After reviewing the facts, we also believe that the contract conveys the right to control the use of
the MV Manhattan to Auto.

- During the contract Auto has the right to obtain substantially all of the economic benefits
from use of the MV Manhattan. The ship is dedicated during the contract to Auto’s
 shipments. Auto also has the option to send the ship below capacity, which shows that
the economic benefits clearly belong to Auto.
- Auto also has the right to control the use of MV Manhattan. Auto determines which
European ports receive shipments and instructs Atlantic of the order in which they want
the deliveries made.

Luxury Car Contract

In our opinion, Auto’s luxury car contract with Atlantic does contain an identified asset.

- The luxury car contract does not have an “explicitly specified” asset like the MV
Manhattan in the sedan contract.
- However, at the time of shipment there is an identifiable asset when the ship shows up,
even if it is a different ship each time. This complies with 842-10-15-9, which states that
“an asset can also be identified by being implicitly specified at the time the asset is made
available for use by the customer”.

However, after reviewing the facts we do not believe that the contract conveys the right to
control the use of the asset to Auto.

- Auto does not have the right to obtain substantially all of the economic benefits from use
of the identified asset. The capacity of the ship is 2,000 cars. Generally, Auto only ships
500. Atlantic is free to use the excess capacity however they see fit and will retain the
economic benefit from that capacity.
- Auto does not have the right to direct the use of the identified asset for either the entire
contract or a portion of the contract, as Atlantic 5 weeks from notification to ship the
cars. Atlantic also has control of delivery order and shipping route.