The ASC 842 Lease Accounting Guide | LeaseCrunch

What is ASC 842 Summary?

The ASC 842 lease accounting 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 companies and their financial statement users, who are typically investors or banks.

ASC 842 lease accounting 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 the ASC 842 lease accounting standard, 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.

Accounting for Sale and Leaseback Transactions

While accounting has become more transparent with ASC 842, there are also additional layers that have been added to the balance sheet that make it more thorough and substantial. One such case includes accounting for sale and leasebacks under the ASC 842 lease accounting standard.

A leaseback is a transaction where the seller of an asset leases back that asset from the entity to which they sold it. For the entity selling and leasing back the asset, this transaction frees up cash while maintaining the use of the asset. This also can improve the balance sheet by making financing less costly than applying for loans, among other benefits. While this removes the owned asset from the balance sheet, the ASC 842 lease accounting standard includes guidance for evaluating these contracts and identifying whether a sale has occurred in a leaseback in accordance with ASC 606.

Because of the lease accounting changes in ASC 842 and ASC 606, some transactions that did not qualify for sale or leaseback accounting under ASC 840 will qualify under ASC 842 and vice versa. Transactions that were accounted for under ASC 840 do not have to be reassessed when transitioning to the ASC 842 lease accounting standard.

ASC 842 Lease Calculation Summary

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, the ASC 842 lease accounting standard 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.

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.

Lease Accounting Under ASC 842

While ASC 842 lease accounting can be complicated, especially when relying on spreadsheets, it doesn’t have to be. With LeaseCrunch’s automated lease accounting software, compliance with the new lease accounting standards has never been easier. Our software is efficient, reliable, affordable, and easy to use, so you can quickly and precisely assure you and your client’s lease accounting information is accurate and up to date. To get started, contact us, or request your demo today. 

FAQs

What Is ASC 842?
ASC 842 is a lease accounting standard by the Financial Accounting Standards Board (FASB), requiring all leases longer than 12 months to be reflected on a company's balance sheet. This enhances financial transparency by giving a clear picture of an entity's lease obligations.

What Is the ASC 842 Implementation Process?
The ASC 842 implementation process involves a series of steps starting with identifying leases and gathering all of an entity's relevant leased assets. The key lease terms are then extracted and subsequently classified as finance or operating leases and are used in calculating the Right-of-Use (RoU) assets and lease liabilities. Monetary values must also be reported on the balance sheet.

What Are the Two Types of Leases Under ASC 842?
Under the ASC 842 lease accounting standard, leases are categorized into two types: operating leases and finance leases. Operating leases are those where the terms do not mimic the purchase of an asset, while finance leases have characteristics that are similar to purchasing an underlying asset.

Is ASC 842 Part of GAAP?
Yes, ASC 842, also known as the new lease accounting standard, is part of the Generally Accepted Accounting Principles (GAAP). It significantly changes how companies account for leases and contributes to the transparency of lease obligations on financial statements.

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 GAAP lease accounting standard you’d like.

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

Is ASC 842 Mandatory?
The ASC 842 lease accounting standard is mandatory for all private companies and nonprofit organizations that follow GAAP and 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, they 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 lease accounting, 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.

What Is the FASB Codification System?
The FASB codification system is the source of authoritative GAAPs recognized by the FASB to be correct and true.

What Leases Are Subject to ASC 842?
For organizations that follow GAAP, all leases 12 months and longer need to adhere to the accounting standards in ASC 842.

How Is ASC 842 Implemented? 
Implementing ASC 842 is complicated. We recommend checking out this guide, reviewing this list of mistakes to avoid, or considering investing in lease accounting software that stays automatically compliant.

How Do I Record a Lease Under ASC 842?
Under ASC 842, all leases 12 months and longer must be identified on the balance sheet. Furthermore, both the lessor and lessee are required to identify these leases.

Does ASC 842 Affect Income Statements?
ASC 842 lease accounting will generally have a minimal impact on a lessee’s income statement.

What Entities Must Comply With ASC 842?
All entities that follow GAAP and have leases longer than 12 months in length must comply with the rules stated in the ASC 842 lease accounting standard.