Under ASC 842, how does Closet Storage Concepts classify its leases?
Closet_Storage_Concepts Franchise · 2025 FDDAnswer from 2025 FDD Document
Leases are classified as either finance leases or operating leases based on criteria in ASC 842. The Company has operating leases for its corporate offices, warehouse space and retail showroom. The Company has finance leases for equipment and vehicles. Such leases generally have original lease terms between two and six years, and often include options to renew. The Company includes options to extend the lease term if the options are reasonably exercised. The Company currently considers its renewal options to be reasonably certain to be exercised. The Company does not have residual value guarantees or material restrictive covenants associated with its leases.
On January 1, 2022, the Company adopted ASU 2016‐02 using the modified retrospective approach, which permits application of this new guidance at the beginning of the period of adoption, requiring single year presentation.
Operating lease assets represent the right to use an underlying asset, and operating lease liabilities represent the obligation to make lease payments arising from the lease. Operating lease right‐of‐use assets and operating lease liabilities are recognized based on the present value of future of minimum lease payments at lease commencement. The Company calculates the present value of its operating leases using an estimated incremental borrowing rate, which requires judgement. The Company estimates the incremental borrowing rate for each operating lease based on prevailing market rates for collateralized debt in a similar economic environment with similar payment terms and maturity dates commensurate with the terms of the lease.
Certain leases contain variable payments, which are expensed as incurred and not included in the Company's operating lease right‐of‐use assets and operating lease liabilities. These amounts primarily include payments for maintenance, utilities, taxes and insurance on the Company's corporate and retail facilities and are excluded from the present value of the Company's lease obligations.
Source: Item 21 — FINANCIAL STATEMENTS (FDD page 59)
What This Means (2025 FDD)
According to Closet Storage Concepts' 2025 Franchise Disclosure Document, the company classifies its leases as either finance leases or operating leases, based on the criteria outlined in ASC 842. Closet Storage Concepts has operating leases for its corporate offices, warehouse space, and retail showroom. Additionally, the company utilizes finance leases for equipment and vehicles. These leases typically have original terms ranging from two to six years and often include options to renew, which Closet Storage Concepts considers reasonably certain to be exercised. The company does not have residual value guarantees or material restrictive covenants associated with its leases.
Closet Storage Concepts adopted ASU 2016-02 on January 1, 2022, using the modified retrospective approach. This approach permits the application of the new guidance at the beginning of the adoption period, requiring single-year presentation. Operating lease assets represent the right to use an underlying asset, while operating lease liabilities represent the obligation to make lease payments arising from the lease. These assets and liabilities are recognized based on the present value of future minimum lease payments at the commencement of the lease.
The present value of operating leases is calculated using an estimated incremental borrowing rate, which requires judgment. Closet Storage Concepts estimates this rate based on prevailing market rates for collateralized debt in a similar economic environment, with similar payment terms and maturity dates commensurate with the terms of the lease. Some leases contain variable payments, such as those for maintenance, utilities, taxes, and insurance, which are expensed as incurred and not included in the company's operating lease right-of-use assets and operating lease liabilities.
For a prospective Closet Storage Concepts franchisee, understanding these lease classifications is crucial. Operating leases will likely cover the showroom or office space, while finance leases may involve equipment necessary for operations. The franchisee should be aware of the lease terms, renewal options, and how variable payments are handled, as these factors can significantly impact the franchisee's financial obligations and profitability.