Q&A from ASC 842: An Introduction to Lessee Accounting Webinar

We recently partnered with Parker + Lynch to bring together over 500 of our closest friends in joining our live webinar, ASC 842: An Introduction to Lessee Accounting. We had a blast, and had to cover a lot of content in a short amount of time, so unfortunately we didn’t have much time to answer participant questions. Instead, we’re taking the opportunity to answer those questions now, via this blog post. Let’s take a look at the questions that other preparers, like yourself, are asking about ASC 842.

Introducing ASC 842

Our webinar began by introducing ASC 842, Leases, particularly talking about why the FASB issued ASC 842 and how it is expected to impact various industries. The bottom line: ASC 842 will result in ALL contracts meeting the definition of a lease being recognized on the balance sheet (unless it meets the definition of short-term lease). Lessees recognize both a right-of-use (ROU) asset and a lease liability. You can learn more about this in this blog post. Here’s a slide from our webinar visually depicting the amount of lease obligations expected to be recorded, by industry, for operating leases that are currently off-balance sheet:

There are only two ways under ASC 842 to get out of having to record the ROU asset and lease liability on your balance sheet:

1. An entity has a lease that is one-year or less and elects to apply the accounting policy election to not recognize short-term leases
2. An entity has a contract that does NOT meet the definition of a lease under ASC 842.

So, let’s look at how ASC 842 defines a lease.

Identifying leases

In order for a contract to contain a lease, it must meet two critical criteria:

1. The lease is for an identified asset; and
2. The lessee must control the use of that identified asset

You can see the various characteristics that must be met in order to meet these two criteria on this slide:

Not too hard to apply, right? But what about embedded leases? Can those exist? YES! We discuss embedded leases, including some great examples, in this blog post.

Determining the lease liability

Now that we’ve determined we do have a lease, it’s time to figure out those day one entries to record the ROU asset and the lease liability. In order to figure out the lease liability, we need a few key inputs:

Lease term

The lease liability is a discounted amount. This means we need to figure out the term over which we will determine the present value of the liability. The lease term begins on the lease commencement date and will include any noncancelable periods. It also should consider:

• Optional renewal periods (if lessee is reasonably certain to renew)
• Periods after a termination date (if lessee is reasonably certain not to terminate)
• Optional periods to extend (if exercise is controlled by lessor)

Lease payments

The lease payments, for purposes of determining the lease liability to be recorded at lease commencement, generally include the following:

Any other lease payments that are not included in the lease liability will simply be expensed by the lessee as paid.

Discount rate

Finally, the last key input in determining the lease liability is the discount rate. Lessees have a few choices when determining the rate to use:

1. The rate implicit in the lease. Many times, this will not be known by the lessee, only the lessor, so this is not likely to be an option widely used by lessees in practice.
2. The lessee’s incremental borrowing rate. The codification defines the incremental borrowing rate as the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.
3. The risk-free rate. This option is ONLY available to private entities. And while it will be easier than determining the incremental borrowing rate for each loan, it may also cause the entity to record a higher lease liability, so entities will need to weigh the pros and cons of the options available.

You can read more about those rates in this blog post.

Initial accounting, classification, and subsequent accounting

After calculating our lease liability, we’re ready to determine and record our ROU asset as well. The ROU asset is calculated as follows:

The initial entries are the same regardless of lease classification. However, the subsequent recognition and measurement will vary depending on whether or not our lease is classified as a finance lease or an operating lease. Here is the lease classification criteria summarized:

And here is a summary of the accounting requirements:

For more information on these areas, check out our Lessee Accounting Explained course, which walks through a few detailed examples.  

Other items

Finally, our webinar concluded with “other issues” to be on the lookout for, including subsequent remeasurement of lease payments, lease modifications, sale-leaseback transactions, and more.

Does this blog leave you thirsty for more information on ASC 842? If so, make sure you check out our ASC 842: Leases course collection, where you’ll find everything you’re looking for – and more!

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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.