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Scope

There is no specific measurement threshold to be met; judgment is required to determine how
significant the supplier’s economic benefits should be for the substitution right to be substantive,
thereby precluding lease accounting.

Generally, a supplier will be in a better position to determine whether it can benefit from exercising a
substitution right, but it may be obvious to a customer that the substitution right benefits the supplier
when there is a clear economic incentive and the barriers to substitution are minimal. When the
customer does not have adequate transparency to the practicality or economics of supplier
substitution rights, it should assume that the substitution right is not substantive and that the
arrangement contains an identified asset. When an asset resides on a customer’s premises, a supplier
generally does not have a substantive substitution right because the costs and potential disruption
would be significant.

Additionally, the assessment as to whether a substitution right is substantive should be based on facts
and circumstances that exist at the inception of the contract. Any circumstances that are not likely to
occur would be disregarded in the analysis. Consideration should also be given to whether the future
events that might occur are within the supplier’s ability to influence. ASC 842-10-15-11 discusses
future events that, at inception, are not considered likely to occur. An example is a provision in a
contract that allows the supplier to substitute the asset for new technology when it is available, but the
technology is not substantially developed at inception of the contract. This would not be considered a
substantive substitution right. The analysis is performed at the inception of the arrangement and does
not consider hypothetical or contingent changes, such as the development of future markets. Rights
that allow for the replacement of certain parts, or the asset as a whole, as a result of loss or wear and
tear are unlikely to be considered substantive substitution rights.

Example 2-3 and Example 2-4 illustrate the effect of substitution rights on the identification of assets.
EXAMPLE 2-3

Supplier with substantive substitution rights

Warehousing Corp owns a large warehouse that can be subdivided into numerous subsections by
inserting removable walls. It leases out different portions of storage space to its customers based on
their respective needs.

Manufacturing Corp contracts with Warehousing Corp to reserve 1,000 square feet of space to store its
excess inventory for a three-year period. The contract states that Manufacturing Corp’s inventory will
be stored in a specified location in the warehouse. However, Warehousing Corp has the right to shift
Manufacturing Corp’s inventory to another location within its warehouse at its discretion, subject to
the requirement to provide 1,000 square feet for the three-year period.

Warehousing Corp frequently reorganizes its space to meet the needs of new contracts. The cost of
reallocating space is low compared to the benefits of being able to accommodate as many customers as
possible in the warehouse.

Does the contract contain an identified asset?

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