Lease Accounting: An Overview of ASC 842
Lease Accounting: An Overview of ASC 842

Lease Accounting: An Overview of ASC 842

Lease accounting… Does it feel like implementation of the “new” standard, ASC 842, has been hanging over our heads forever?

Issued by the Financial Accounting Standards Board (FASB) in early 2016, ASC 842 became effective for public business entities with calendar year-ends in January 2019, requiring almost all leases to be recorded on-balance sheet. The impact was estimated to be $3 trillion in liabilities recorded to corporate balance sheets!

Initially, the effective date of ASC 842 for non-public business entities was January 1, 2020, but last year, the FASB pushed back the effective date to January 1, 2021. And last week, the FASB voted to provide more time for private companies due to the COVID-19 pandemic, delaying the effective date to fiscal years starting after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022. Early application is allowed.

Although the delay surely will provide some relief to private entities, it is important for companies to keep pushing forward as implementation may not be a simple, straightforward undertaking.

Why is that?

Aren’t we just recording leases on the balance sheet now?

Well, yes. But there are complexities and adoption could require a rather rigorous implementation effort.

For example, before even applying lease accounting, entities need to determine whether a contract is a lease or contains a lease and thus within the scope of lease accounting. This can be time consuming and a bit of a struggle as not all contracts that meet the definition of a lease are clearly labeled as a lease.

Additionally, companies do not always have a centralized person or department that enters into all contracts for the company. As you can imagine, depending on how large your organization is, it may take some time to inventory all contracts and then review them from the lens of identifying whether in whole the contract is a lease or whether parts of the contract meet the definition of a lease.

Another potential issue you may need to deal with is identifying and separating lease and non-lease components. This is important because if a lease agreement contains non-lease components, they should be separated and accounted for in accordance with other applicable accounting standards (unless a lessee makes the permitted accounting policy election).

So, these are just a few of the complexities that need to be addressed with ASC 842. There is a lot to know about accounting for leases before even getting to recognition and measurement on the balance sheet. But, let’s get to an overview of the actual accounting…

Overview of Lease Accounting for Lessees

From a lessee’s perspective under ASC 842, all leases will be recorded on balance sheet with the exception of short term-leases if the lessee elects the recognition and measurement exemption for those leases.

There is a dual model approach for lessee accounting. At lease commencement, a lessee will classify a lease as either a finance lease or an operating lease.

Also, at the commencement date of the lease, a lessee will recognize a lease liability, which represents the lessee’s obligation to make lease payments to the lessor, and a ROU asset, which represents the lessee’s right to use the underlying asset during the lease term.

The initial recognition of the ROU asset and the lease liability is the same for finance leases and operating leases. Subsequent accounting and financial statement presentation for the lease depends upon the lease classification.

Overview of Lease Accounting for Lessors

At the commencement date of a lease, a lessor will classify leases as:

  • A sales-type lease
  • A direct financing lease, or
  • An operating lease

For sales-type and direct financing leases, a lessor derecognizes the underlying asset and recognizes a net investment in the lease. For operating leases, a lessor does not derecognize the leased asset at the commencement date.  

The requirements of ASC 842 are quite extensive, so it is not possible to cover everything here. If you want to obtain more in-depth knowledge and understanding of lease accounting we recently released our four-part lease accounting training collection that covers the requirements of ASC 842 in more detail. In the remainder of this blog post, I am going to introduce our accounting for leases training courses.

Lease Accounting Training 

Planes, trains, and automobiles! That is the theme of our ASC 842 training series. Here’s a sneak peak into each lease accounting eLearning course.

Course 1 – Leases: Overview of ASC 842

Earlier, I mentioned the requirements of determining whether a contract is a lease and separating lease and non-lease components. There are additional fundamental key concepts that you must understand to apply the lease accounting guidance. These are covered in the first course of the lease collection series.

In this overview of lease accounting course, you will learn:

  • The definition of a lease and how to apply the definition to be able to determine what contracts or contract terms are required to be accounted for under ASC 842
  • Scope exceptions to ASC 842
  • The practical expedient for short term leases
  • How to identify and separate lease and non-lease components
  • Allocating contract consideration
  • The key concepts of the lease term, lease payments, and discount rate which are needed to classify and measure leases
  • The various lease classifications and the criteria for lessees and lessors to appropriately classify leases, and
  • An overview of the accounting by lessees and lessors based on lease classification

Take me to this course!

Now that you know the key concepts to lease accounting and are able to identify a lease, the next two courses in the lease accounting training series go into more depth on lessee accounting and lessor accounting.

Course 2 – Leases: Lessee Accounting Explained

While I provided an overview of lessee accounting above, that only scratches the surface. In this course you will dive deeper into lessee accounting. You will learn:

  • The dual model approach and the specific criteria for determining whether a lease is a finance lease or an operating lease
  • How to calculate the lease liability and the right of use asset in order to initially recognize a lease on the balance sheet
  • Subsequent measurement of a lease based on whether the lease is classified as a finance or operating lease, and
  • Presentation and disclosure requirements

Take me to this course!

Course 3 – Leases: Lessor Accounting Explained

In the third course of the ASC 842 lease accounting series, we look at leases form the lessor’s perspective. You will learn:

  • The three lease classifications and the criteria to classify a lease as either a sales-type lease, a direct financing lease, or an operating lease
  • Initial recognition of a lease based on the classification
  • Subsequent measurement of a lease based on the classification
  • Other lessor specific guidance related to separating components of a contract and lease modification accounting, and
  • Presentation and disclosure requirements

Take me to this course!

Finally, the last course in the ASC 842 training series dives into accounting for changes after the commencement date.

Course 4 – Leases: Changes After The Commencement Date

Just because you got through getting leases recorded on the balance sheet doesn’t mean you can kick back and put lease accounting on cruise control! As the saying goes, “Change is the only constant in life” and just as things can change in life, things can change with a lease during the contract life.

Certain events may occur that would require you to reassess key estimates and judgments on your leases and/or to remeasure lease payments. Other changes that have accounting implications are modifications to the lease and lease terminations.

So, in this course, you will learn:

  • When a contract should be reassessed
  • Remeasurement of lease liabilities and right of use assets by the lessee or the net investment of the lease by the lessor
  • Accounting for lease modifications, and
  • Accounting for lease terminations

Take me to this course!

As you can see, there is quite a lot to learn about lease accounting! Regardless of whether the guidance is effective yet for your entity, lease accounting is COMPLEX. Investing in your knowledge and education on the topic will be critical for successful implementation and for ongoing continued compliance with the intricacies of ASC 842.

We are here to help! Our ASC 842 eLearning courses break down the complex accounting rules into a more easily understandable manner. Whether you choose a specific course or need the 4-part lease accounting training series, we have you covered with comprehensive, engaging, and entertaining ASC 842 lease accounting training! Additionally, check out our Leases topic page for more resources.

About GAAP Dynamics  

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This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.

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Comments (4)

  1. Will Moeller:
    Mar 15, 2021 at 04:12 PM

    So is the standard effective 1/1/22 for private companies or 12/31/21?

  2. Mike Walworth, CPA:
    Mar 15, 2021 at 04:47 PM

    It is effective for fiscal years beginning on or after December 15, 2021. That means, for private entities with calendar year ends, ASC 842 is effective beginning January 1, 2022.

  3. Al Priem:
    Sep 15, 2022 at 03:34 PM

    Our lease calls for payment of a fixed some and then .029 % of sales taxes per month. Is the sales tax included as a rent payment for calculating the NPV calculation? Thank you

  4. Michael W Walworth:
    Sep 19, 2022 at 10:25 AM

    Taxes and insurance are NOT part of the lease payments and should not be included in the lease liability to be recorded on the balance sheet.

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