When changes to accounting standards impact assets and liabilities, we are accustomed to also adjusting equity. However, the new lease accounting standard, ASC 842, handles these adjustments differently. While it seems strange to skip using the “Cumulative Effect of a Change in Accounting Principle” account when implementing the new standard, it’s the right thing to do to ensure the lease assets and lease liabilities are properly recorded. Read on to learn more.

When transitioning leases from ASC 840 to ASC 842, start by calculating the lease liability, which is the present value of all future lease payments occurring after the Initial Application Date. This includes monthly rents, known escalators, residual value guarantees and more.

Next, remove existing lease balances such as operating lease deferred rent or capital lease assets and liabilities. As you reverse these balances off the books, they should flow through the Right of Use (ROU) Asset, not through equity, as is common when implementing a new accounting standard. In most cases, the ROU asset is the lease liability plus or minus the differences of those existing balances.

Note: As with most rules, there are exceptions where equity will actually be affected depending on policy elections and other scenarios. You’ll find a list of exceptions in this guide.

Items that could also be included as existing balances are unamortized initial direct costs or unamortized incentives received from lessor. Keep this in mind when preparing for transition to the new standard.

Missteps to avoid

The lease transition entries for ASC 842 differ from most accounting standard changes so there are some mistakes to avoid when making this transition.

• While it may be tempting to have the ROU Asset and Liability equal while adjusting the operating lease deferred rent balances through an equity account, it’s incorrect recording of these balances. Any existing balances will be adjusted through the ROU Asset, therefore the ROU Asset and Lease Liability may not equal.
• When transitioning a capital lease from ASC 840 to ASC 842, the existing balances will be reversed and the difference will flow through the ROU Asset. Note that this will also cause the ROU Asset and Lease Liability not to equal.
• It is also important to remember that at transition, the lease liability is a “stake in the sand” as the present value of future lease payments, the lease liability is based on what is actually owed to the lessor. Any changes will be made through the ROU Asset.

Additional resources

This topic is a perfect opportunity to reach out to clients to ask if they need assistance implementing ASC 842. Here are some excellent resources:

• Transitioning to the New Lease Standard (With Sample Journal Entries)

• Lease Review Checklists for Office Space and Vehicle Leases

Although transitioning to the new lease accounting standard is fairly straightforward, spreadsheets become risky as soon as you have more than a few leases. LeaseCrunch is a software solution that vastly simplifies the process of transitioning to ASC 842, including prompts for entering existing balances, creating initial journal entries and performing quantitative calculations for footnote disclosures. Learn more or request a demo here.