What Is ASC 842? The Ultimate Guide

What is ASC 842 Summary?

The ASC 842 standard for GAAP lease accounting requires all leases longer than 12 months to be recorded as assets and liabilities on balance sheets. The Financial Accounting Standards Board, or FASB, created this new standard to foster more transparency between investors and companies. 

ASC 842 is a replacement for the previous GAAP lease accounting standard, ASC 840, under which certain leases might have been classified as “operating leases” and therefore not capitalized onto the balance sheet. As a result, they were excluded from many financial analysis ratios, such as return on assets, and these exclusions could give an investor a false depiction of a company’s performance.

Now, with ASC 842, all organizations that follow generally accepted accounting principles, or GAAP, are required to categorize all leases as both liabilities and right-of-use assets.

ASC 842 Lease Accounting

With the adoption of ASC 842 comes significant impacts on the balance sheets of many companies. Even if an organization only has a single lease, it’s often for real estate and therefore can have a large impact on the financial statements. Further, companies can, and do, lease far more than simply office space. 

Leased assets can include computers, telephones, vehicles, heavy equipment, and warehouse space. Not to mention, leases can be embedded into service and usage contracts as well as amongst other expenses, proving difficult to find. 

Finding all of these leases and recategorizing them will be a headache for many companies as they implement the new GAAP lease accounting standard, especially those with decentralized operations. Needless to say, ASC 842 lease accounting is a bit more complex than lease accounting was before the release of the new standard. If you’re interested in learning more about transitioning leases from ASC 840 to ASC 842, click here.

ASC 842 Lease Calculation

Previously, under ASC 840, accounting for operating leases was easier than accounting for capital leases because lease payments were simply expensed on a straight-line basis. A capital lease under ASC 840 is similar to a finance lease under ASC 842, including the definition and calculations. The concept of an operating lease also remains the same, with a big difference: the present value of committed future payments must be recorded on the balance sheet as a lease liability, offset by a right-of-use asset. 

After entering into and properly booking a lease, something about the lease might need to change. For example, a tenant adds or reduces the square footage of the space they are renting, a vehicle is damaged, or equipment is returned early. Depending on the facts and circumstances of the lease revisions, ASC 842 might consider the revision a modification, a remeasurement, or an impairment. 

Each of these revisions requires different inputs for the lease calculation to be updated, which can be difficult and confusing. Learn more about how you can help prepare your clients for these changes here.

Entities that Must Comply with ASC 842

All entities that follow generally accepted accounting principles and have leases longer than 12 months in length must comply with the rules stated in ASC 842.

When is ASC 842 Effective For Private Companies?

The ASC 842 effective date is December 15, 2021, meaning that after this date, ASC 842 is  first effective for the annual reporting periods of private companies and nonprofit organizations, then also required for interim reporting periods after that.  This effective date was delayed to allow organizations accounting relief from previous accounting standard changes and then during the COVID-19 global pandemic. Read more about how the pandemic affected leases here.

An update to ASC 842 was announced by the FASB to provide relief on identifying discount rates. A discount rate is applied to future lease payments to determine the lease liability. Originally, ASC 842 required companies to select one discount rate calculation methodology for all leases. The relief granted by the FASB allows companies to choose the type of discount rate methodology by asset class. 

This relief is important because it allows an organization to spend time calculating an incremental borrowing rate for large-value leases like office space, thereby reducing the lease liability. For smaller leases that are less material to the financial statements, an organization can simply use the appropriate risk-free rate.

What is the Best ASC 842 Software?

To properly adjust to the changing scene of GAAP lease accounting, companies will benefit significantly from investing in a software solution to manage their transition to ASC 842. When in the market for ASC 842 lease accounting software, it’s important to look for a solution that hits several main areas of focus:

• Efficiency: Manual calculations take time, especially with more intricate lease accounting standards. Software can crunch numbers and save you money and time.
• Ease of use: Software should simplify ASC 842 implementation, not make it more confusing. Look for a platform that has a user-friendly interface for ease of use and integration.
• Customization and control: Look for a software solution that scales to your organization and is modifiable based on the features you want.
• Security: Choosing a technology that is secure is just as important as choosing one that is fast and accurate. When SOC 1 Type II and SOC 2 Type II reports are available for software, that means they offer additional assurances around security and processing integrity.
• Expertise: Select software created by a team of accounting experts, not just software engineers. Here at LeaseCrunch, we specialize in accounting and software solutions to ease the burden of lease accounting on your firm.

Bottom Line

LeaseCrunch is the best option in the GAAP lease accounting software space. Our software is efficient, reliable, and affordable while helping your company maintain accounting compliance and accuracy. Get a demo today.

FAQs

How many ASC standards are there?

There are around 90 generally accepted accounting principles (GAAP) that have been released and recognized by the FASB. You can browse the FASB Codification list here and view any lease accounting standard you’d like.

What is ASC US GAAP? 

ASC stands for accounting standards codification, and GAAP stands for generally accepted accounting principles. The ASC US GAAPs are a set of accounting standards released and maintained by the Financial Accounting Standards Board.

Is ASC 842 Mandatory?

ASC 842 is mandatory for all private companies that have leases longer than 12 months.

Is IFRS the Same as ASC 842?

When it comes to operating leases under IFRS 16 and ASC 842, IFRS 16 and ASC 842 diverge in intent and effect. Under IFRS 16, there are only finance leases - the International Accounting Standards Board eliminated the concept of the operating lease. In the U.S. under ASC 842, organizations still need to classify leases as either operating or finance leases. Despite this difference, both require all leases over 12 months in length to be recorded on the balance sheet.