April 15, 2026
Written by Christa Julien, CPA
It has been nearly five years since Accounting Standards Update No. 2016-02, Leases (Topic 842) became effective for private entities, requiring companies to bring leases onto the balance sheet.
For private manufacturers, lease accounting is no longer a back‑office task — it’s a strategic finance issue. As companies modernize plants, adopt automation and navigate supply chain pressures, lease arrangements have the potential to be more complex than ever.
Each agreement you enter has its own nuances and intricacies. While navigating leases can be challenging, there are three areas we recommend considering.
Embedded Leases
Embedded leases can be hiding in your contracts. While not explicitly named a “lease,” a contract that contains the right to use a physical asset of which you benefit from, could qualify as a lease agreement requiring capitalization under ASC 842. Some examples of embedded leases in the manufacturing world include supply agreements, transportation and logistic contracts, information technology, and contract manufacturing, just to name a few. The following are examples of how embedded leases may look:
- A long-term supply agreement in which a supplier dedicates a specific production line (using the company’s tooling) exclusively to manufacture the company’s product. In this situation, the company effectively has the right to use that identified production line, so the arrangement may contain an embedded lease.
- A logistics contract where a company is granted exclusive use of a designated section of a shipping terminal dock that meets its fleet’s specifications for a multi‑year period. The exclusive dock space can be an identified asset, and the contract may contain an embedded lease of that dock area.
Unidentified embedded leases can result in understated assets and liabilities leading to debt covenant risks and audit findings.
Variable Lease Payments
Remember that under ASC 842, most variable lease payments (other than those based on an index or rate) are excluded from the initial lease liability and are recognized as an expense as they are incurred.
Variable lease payments are common for manufacturing companies. Many leases contain per-machine-hour pricing, per-unit-produced fees, index increases, and performance or consumption-based add-ons. As variable lease payments are not part of the initial lease liability, they can create swings in operating costs and margins. It’s important to ensure that forecasting models connect the effect of variable costs to production to create more accurate results.
Lease Renewals
Many companies operate custom shops with extensive tenant improvements, which will likely impact the assessment of the initial lease term. Renewal options that are reasonably certain to be exercised must be included in the initial measurement of the lease asset and liability. A common mistake after entering into a lease is failing to reassess the lease term and remeasure the lease liability when a significant event or change in circumstances within the lessee’s control occurs—such as constructing significant leasehold improvements—that makes it reasonably certain the lessee will exercise a renewal option. In addition, when a lessee elects to exercise a renewal option that was not previously included in the lease term, the reassessment and remeasurement are triggered on the date the option is exercised, not when the extended lease period begins.
Key Take Aways
Lease accounting in manufacturing is no longer just about compliance. It affects liquidity, margins, debt ratios, capital planning, and audit outcomes. Clark Nuber has a team of professionals dedicated to serving the manufacturing and consumer products industry. For more tips and guidance relating to manufacturing accounting, connect with our team to start a conversation.
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