The Definitive Guide To ASC 842 Lease Accounting

The new ASC 842 Lease Accounting standard is a major shift in the way companies account for leases. It replaces the previous standard, ASC 840, and affects public and private companies. 

The new standard requires companies to recognize a right-of-use asset and lease liability for all leases, with the exception of short-term leases. This means that companies must now recognize the costs associated with their leases on their balance sheets. 

The new standard is complex and requires a comprehensive understanding of the rules and regulations. Companies must be able to accurately calculate the lease liabilities and assets, as well as properly account for them. These are a few reasons why companies often opt to use software solutions to help them with their transition to the new standard.

In this guide, we will provide an overview of the ASC 842 standard, how it affects public and private companies, lease calculation rules, the best software to use, tips for streamlining adoption, and more. 

We will also answer some of the most commonly asked questions about the new standard. With this information, you will be able to successfully transition to ASC 842 and overcome any challenges.

Ready to transition to the ASC 842 Lease Accounting standard? Let Netgain give you a good grasp of the new lease accounting standard relevant to you!  

What Is ASC 842 Lease Accounting?

ASC 842 Lease Accounting is an accounting standard set forth by the Financial Accounting Standards Board (FASB). It is designed to provide a more transparent and consistent approach to accounting for leases. 

Under ASC 842, a lease is defined as a contract, or part of a contract, that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. This includes both operating and finance leases, as well as sale-leaseback arrangements.

The ASC 842 standard is effective for public companies for fiscal years beginning after December 15, 2018, and for private companies for fiscal years beginning after December 15, 2021. Companies must adopt the standard using a modified retrospective approach.

How Does ASC 842 Lease Accounting Work?

The ASC 842 Lease Accounting standard is an accounting guidance released by the Financial Accounting Standards Board (FASB) in February 2016. The standard requires companies to recognize lease assets and liabilities on their balance sheets, providing more transparency into their financial statements.

Under ASC 842, companies must recognize a right-of-use (ROU) asset and a lease liability for all leases with a term of more than 12 months. The ROU asset represents the right to use the leased asset for the duration of the lease, while the lease liability represents the obligation to make payments over the term of the lease.

The ROU asset and the lease liability are calculated by multiplying the lease term and the present value of the lease payments. The present value of the lease payments is determined by discounting the payments at the company’s incremental borrowing rate (IBR). 

The IBR is the rate of interest that the company would have to pay to borrow the funds necessary to make the lease payments over the term of the lease.

At the end of each reporting period, companies must measure the ROU asset and the lease liability at their current fair value. The lease liability is measured as the present value of the remaining lease payments. The ROU asset equals the lease liability plus any prepaid lease payments, initial direct costs, minus any lease incentives received from the lessor.

The ASC 842 Lease Accounting standard also requires companies to recognize a lease expense for each reporting period. The lease expensed in different fashion depending on type the lease is catogized as.

ASC 842 Lessee Accounting Types

Under ASC 842 there are hand full of different lease types your leases could fall under.  The type of lease accounting used by a lessee depends on the nature of the lease and the terms of the agreement. 

There are four main types of lease accounting under ASC 842: operating leases, finance leases, sale-leaseback accounting, and leveraged leases.

Operating Lease Accounting Under ASC 842

Operating leases are a common form of lease accounting under ASC 842. An operating lease is a lease agreement in which the lessee (the company that is leasing the asset) does not obtain ownership of the asset and does not have the right to purchase the asset at the end of the lease term. 

Operating leases are also known as service or rental agreements. 

Under ASC 842, operating leases are required to be reported on the balance sheet as a liability, where as these used to be directly expenses on a monthly basis. The expense is instead recognized using recognized using a straight line over the lease terms. 

The lease expense is calculated by taking the sum of all lease payments, lease prepayments at the start of the lease, initial direct costs, and subtracting any lease incentives.The resulting number is then divided by the terms of the lease which provides you with an accurate straight line recognition of the lease expense over the term of the lease. 

The lease payments are typically equal payments, but they may also include variable payments such as a percentage of sales or a fixed amount. The lessee must also disclose information about the lease, such as the nature of the lease, the expected term, and the total minimum lease payments. 

Finance Lease Accounting Under ASC 842

Finance lease accounting under ASC 842 is the accounting for leases in which the lessee takes ownership of the leased asset at the end of the lease term. The lessee must recognize the asset and the corresponding liability on the balance sheet. 

The lessee must initially measure the liability at the present value of the lease payments. The asset is measured at the lower of the present value of the lease payments or the fair value of the asset. The lessee must also recognize a right-of-use asset, which represents the right to use the leased asset during the lease term. 

The lessee must recognize amortization expense and interest expense throughout the life of the lease. Amortization expense is reducing the ROU balance on a straight line basis over the life of the lease where as the interest expense is calculated by multiplying the balance of lease liability at the beginning of the period by the IBR divided by the length of the period as a fraction of the year. 

However, interest and amortization calculations are complicated and can be easily calculated using our free accounting tools at Netgain. 

This means more expense is recognized at the beginning of the lease than towards the end. 

Finance lease accounting under ASC 842 is complex and requires careful consideration of the rules and regulations. Companies should consult with their accountants to ensure they are in compliance with the standard.

Lessor Accounting Under ASC 842

Lessor Accounting Under ASC 842 is a set of rules that governs the accounting for leases from the lessor’s perspective. A lessor is a party that owns property or equipment and leases it to another party. Under ASC 842, lessors must recognize a lease asset and a lease liability for all leases that meet the definition of a lease under the standard. 

The lease asset represents the right to receive payments from the lessee. The lease liability represents the lessor’s obligation to make payments to the lessee. The lease asset and the lease liability are initially measured at the present value of the lease payments. 

The lease asset is then amortized over the term of the lease, while the lease liability is reduced by the payments made by the lessee. 

The lessor must also recognize revenue related to the lease. The revenue is recognized on a straight-line basis over the term of the lease. The revenue is equal to the difference between the lease payments and the amortization of the lease asset. 

In addition, the lessor must recognize a gain or loss on the sale or termination of a lease. The gain or loss is equal to the difference between the proceeds from the sale or termination and the carrying amount of the leased asset. 

Finally, the lessor must recognize any impairment of the lease asset. If the expected future cash flows from the lease are less than the carrying amount of the lease asset, the lessor must recognize an impairment loss.

Sale-Leaseback Accounting Under ASC 842

Sale-leaseback accounting is a type of lease accounting under ASC 842. It is a transaction in which the owner of an asset sells the asset to a third party and then leases it back from the same party. This type of transaction is often used to raise capital or to finance operations.

Under ASC 842, sale-leaseback accounting is treated as a financing transaction rather than an operating lease. This means that the lessee must recognize a right-of-use (ROU) asset and a lease liability on the balance sheet. The ROU asset is equal to the present value of the lease payments, and the lease liability is equal to the same amount.

The lessee must also recognize a gain or loss on the sale of the asset and interest income or expense on the lease liability. The gain or loss is the difference between the amount received from the sale and the carrying amount of the asset. This gain or loss is recognized in the income statement.

The lessee must also recognize depreciation expense for the ROU asset. This is calculated using the straight-line method and is recognized in the income statement.

Finally, the lessee must recognize rent expense equal to the lease payments due on the lease liability. This is recognized in the income statement.

Leveraged Lease Accounting Under ASC 842

Leveraged lease accounting under ASC 842 is a type of lease accounting that involves the use of a third-party lender to finance the lease. This type of lease is typically used to finance large-scale purchases, such as airplanes or other large pieces of equipment. 

The lender provides the lessee with the funds to purchase the asset and the lessee agrees to make payments to the lender over the life of the lease. The lender then leases the asset to the lessee and provides a portion of the lease payments to the lessor.

Under ASC 842, leveraged leases are accounted for similarly to finance leases. The lessee must recognize a right-of-use asset and a corresponding lease liability for the lease payments. 

The right-of-use asset is measured at the present value of the lease payments, discounted at the rate implicit in the lease. The lessee must also recognize interest expense on the lease liability and amortization of the right-of-use asset over the lease term. 

The lessor must also recognize a lease receivable and a corresponding deferred income liability. The lease receivable is measured at the present value of the lease payments, discounted at the rate implicit in the lease. The lessor must also recognize interest income on the lease receivable and amortization of the deferred income liability over the lease term. 

Under ASC 842, leveraged leases are subject to the same disclosure requirements as finance leases. Lessees must disclose the right-of-use asset, the lease liability, and other information related to the lease. Lessors must disclose the lease receivable, the deferred income liability, and other information related to the lease. 

Overall, leveraged leases are a type of lease accounting that involves the use of a third-party lender to finance the lease. 

Under ASC 842, leveraged leases are accounted for similarly to finance leases, with both the lessee and lessor recognizing assets and liabilities for the lease payments. Leveraged leases are also subject to the same disclosure requirements as finance leases.

Effective Dates For ASC 842 Lease Accounting

The effective date for ASC 842 Lease Accounting depends on the type of organization that is adopting the standard. For public companies, the effective date is for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. 

For private companies, the effective date is for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years.

For Public Companies

For public companies, the ASC 842 Lease Accounting standard went into effect for fiscal years beginning after December 15, 2018. This means that any public companies that had a fiscal year beginning after this date must comply with the new standard. 

For Private Companies

Private companies have their own set of considerations when it comes to adopting the ASC 842 lease accounting standard. The most important factor for private companies is the effective date for adoption. The effective date for private companies is the beginning of the period after December 15, 2021. 

This means that private companies have more time to prepare for the adoption of the standard than public companies. 

Private companies should also be aware of the scope of the standard. The scope of the standard applies to all leases with a term of more than 12 months, regardless of their classification. 

This means that private companies need to be prepared to account for both operating and finance leases under the standard. 

Private companies should also be aware of the new rules for accounting for sale-leaseback transactions and leveraged leases. 

Finally, private companies should be aware of the best software to use for ASC 842 lease accounting. The best software to use for private companies is a cloud-based accounting system that is specifically designed for lease accounting. 

Best Software For ASC 842 Lease Accounting

When transitioning to ASC 842 Lease Accounting, selecting the right software for your organization is essential. The right software can help streamline the transition process and ensure accuracy and compliance. 

When selecting a software solution, there are several factors to consider. It’s important to choose a system that is comprehensive, user-friendly, and can provide all the features and functionalities needed to comply with the new standards. 

The best software for ASC 842 Lease Accounting should include features such as:

• Automated lease management: Automated lease management can help streamline the transition process and ensure accuracy and compliance. It should include features such as automated lease abstracting, lease data entry and validation, lease payment tracking, and lease compliance monitoring. 
• Reporting: Robust reporting capabilities are essential for understanding and tracking the impact of the new standards. The software should include features such as customizable reports, dashboards, and analytics to give you a comprehensive view of your lease portfolio. 
• Integration capabilities: Integration capabilities are key to ensuring accuracy and compliance. The software should be able to integrate with other systems such as ERP, accounting, and financial systems to ensure data accuracy and consistency.
• Security and scalability: Security and scalability are important considerations when selecting a software solution. The software should have strong security measures in place to protect your data, and should be able to scale as your organization grows. 

Visit Netgain to learn how we can help you centralize all leases onto a single platform, perform calculations, assist with lease administration, and provide necessary information for reporting!

Tips For Adopting & Streamlining The ASC 842 Lease Accounting

 Adopting and streamlining the ASC 842 lease accounting standard can be a daunting task, but there are several tips that can help make the process easier.

1. Get organized. Before you begin, make sure you have a comprehensive list of all your leases and that you understand the terms of each one. This will help you identify any potential issues and ensure compliance with the standard.

2. Automate. Utilizing lease accounting software can help streamline the process and ensure accuracy. This type of software can help you track leases, manage lease payments, and generate reports.
3. Train your staff. Make sure your staff is well-versed in the ASC 842 standard and can accurately apply the rules to your lease accounting. 
4. Review your processes. Take the time to review and update your processes to ensure that you are meeting the requirements of the standard. This will help you avoid any potential issues and ensure compliance.
5. Monitor your compliance. Once you have implemented the ASC 842 standard, it is important to stay up-to-date on any changes or updates to the standard. This will help you remain compliant and ensure accuracy in your lease accounting.

By now, you have a good understanding of how the new lease accounting standards have changed. Learn more on how NetLease covers all the new complexity of lease accounting in a simple but powerful solution.

Final Thoughts

The ASC 842 lease accounting standard is an important and complex change for all companies, public and private. It requires a thorough understanding of the rules, the best software to use, and the tips and tricks to streamline the adoption process. With the right preparation, however, the transition to ASC 842 can be a smooth one. 

Overall, understanding the ASC 842 lease accounting standard is essential for all companies, public and private. With the right preparation, the transition to the standard can be a smooth and successful one.

What are you waiting for? Simplify your ASC 842 lease accounting standard transition with NetLease, the stand-out solution by Netgain. 

FAQs 

How do you account for leases under ASC 842?

ASC 842 requires lessees to recognize a right-of-use asset and a lease liability for all leases with a term of more than 12 months. The right-of-use asset is recorded at the present value of the lease payments, while the lease liability is recorded at the present value of the same lease payments.

The right-of-use asset is then amortized over the lease term, while the lease liability is reduced as payments are made. 

How is rent expense recorded under ASC 842?

Under ASC 842, rent expense is recorded in the period in which it is incurred. This means that rent expense is recorded when the lessee has the right to use the leased asset, regardless of when the payment is due. 

Is ASC 842 the same as IFRS 16?

While ASC 842 and IFRS 16 are both accounting standards for leases, they are not the same. IFRS 16 is a more comprehensive standard than ASC 842, and it requires lessees to recognize a right-of-use asset and a lease liability for all leases with a term of more than 12 months. 

What is the journal entry for a lease?

The journal entry for a lease under ASC 842 requires the lessee to record a debit to the right-of-use asset account and a credit to the lease liability account for the present value of the lease payments. 

Should leases be capitalized or expensed?

Under ASC 842, leases with a term of more than 12 months must be capitalized. This means that the lessee must record a right-of-use asset and a lease liability for the present value of the lease payments. The right-of-use asset is then amortized over the lease term, while the lease liability is reduced as payments are made. 

Is a lease a liability or an asset?

Under ASC 842, a lease is both a liability and an asset. The lessee must record a right-of-use asset and a lease liability for the present value of the lease payments. The right-of-use asset is then amortized over the lease term, while the lease liability is reduced as payments are made. 

What is the difference between a financial lease and an operating lease under ASC 842?

Under ASC 842, a financial lease is a lease that transfers substantially all of the risks and rewards of ownership to the lessee. An operating lease is a lease that does not transfer substantially all of the risks and rewards of ownership to the lessee. Financial leases must be capitalized while operating leases are expensed as incurred.