ASC 842 Summary

Understanding the ASC 842 lease accounting standard

Everything you need to know in one place

ASC 842 Overview

The lease accounting standards were established to prevent the ﬁnancial statement fraud of companies like Enron and WorldCom, while addressing the lack of debt transparency in reporting. In 2019, the latest Financial Accounting Standards Board (FASB) standard on lease accounting, ASC 842 (ASU 2018-11), went into eﬀect for most public companies. Private companies and universities were granted a later adoption date, which has now been extended to years beginning after December 15, 2021, and interim periods within ﬁscal years beginning after December 15, 2022. At this point, all public and private entities are required to comply with ASC 842.

What is ASC 842?

The most signiﬁcant change in ASC 842 is that most operating leases need to be recorded on the balance sheet. ASC 842 closed a loophole which allowed corporations to hide certain assets and liabilities oﬀ-balance sheet. Under the standard, companies are required to capitalize most leases on the balance sheet — reporting them as right-of-use (ROU) assets and lease liabilities. As a result of the shift, auditors are paying more attention to capitalized lease obligations, pushing companies to focus on the accuracy and completeness of what they report while improving the transparency and comparability of ﬁnancial statements.

ASC 842 deadlines

The ASC 842 effective date varies for private companies depending on their ﬁscal year close (see the table). Public companies had to comply in 2019. Early adoption is permitted for all organizations, but only a few major public companies elected to early adopt. It’s time for private companies to start identifying leases, extracting data, loading data into ASC 842 software, and testing the system under the new accounting standard.

Quick Start Guide

6 steps to finding
and loading lease data

What's new under the ASC 842 standard

The biggest change is the capitalization of operating leases, which occurs under both FASB’s ASC 842 and the International Accounting Standard Board’s (IASB) IFRS 16. However, there are a few diﬀerences between ASC 842 and IFRS 16 – ﬁrst, they split on how to classify leases to be capitalized on the balance sheet. The FASB created a dual classiﬁcation model of operating and ﬁnance leases, while the IASB determined that all on-balance-sheet leases will be accounted for as ﬁnance leases.
Under ﬁnance lease accounting, an asset and a liability are recorded at the present value of the lease payments on the balance sheet, with certain modiﬁcations for items such as prepayments and initial direct costs. On the income statement, the lease costs are recorded as a straight-line amortization expense plus a declining interest expense.

Organizations will need to use either the interest rate from the lease or the practical expedient of the Incremental Borrowing Rate (IBR) to calculate present value.
Under the FASB’s operating lease accounting standard, operating leases are capitalized similarly to ﬁnance leases (previously called capital leases under ASC 840). However, the proﬁt and loss (P&L) expense remains as a straight-line average expense.
The FASB and the IASB allow a short-term lease (12 months or less) exemption from lease capitalization. The IASB allows an exemption from capitalization for leases less than or equal to US$5,000 in value.

ASC 842 examples

We’ve built a set of lease accounting examples to help you get started. Use our free ASC 842 lease accounting examples below to understand how the standard works or see the ASC 842 journal entries in real-time in our free trial.

Classifying leases with ASC 842

Determine whether your leases are operating or ﬁnance leases under ASC 842 using this lease classiﬁcation decision tree.

Handbook

ASC 842 guide

This is a brief introduction to ASC 842. For more detail on the technical accounting as well as how companies can successfully achieve and maintain compliance with the standard, download our full ASC 842 Handbook

History

What is the difference between ASC 840 and ASC 842?

One of the accounting loopholes the SEC identiﬁed was off-balance sheet operating leases. Under the ASC 840 standard, leases were classiﬁed as capital leases or operating leases. Capital leases were reported on the balance sheet. Operating leases were disclosed in the footnotes of your ﬁnancial statements as “off-balance sheet” operating expenses and excluded from important ﬁnancial ratios, such as return on assets, that investors use to judge a company’s performance.

The diﬀerent accounting treatment for operating leases made it challenging for investors to gain an accurate understanding of a company’s real indebtedness. The SEC determined the confusion was a big problem. They asked FASB, which creates the standards for U.S. General Accepted Accounting Principles (GAAP), to work with IASB, which creates standards for the rest of the world, on a new, global standard.

Building the current lease accounting standards

FASB and IASB received comments from lessees, lessors, investors, and the general accounting community on one discussion paper and two exposure drafts. In February 2016, they ﬁnalized ASC 842 and IFRS 16. While the boards didn’t converge on a single lease accounting standard, both standards still bring a much higher level of transparency to leases. Now, companies must capitalize all leases longer than 12 months on their balance sheets as assets and liabilities.

The history of these lease accounting standards goes back even further. For a complete guide to ASC 842, read the timeline below. For an IFRS 16 timeline, click here.

Timeline: the history of lease accounting
(ASC 842)

The Committee on Accounting Procedure determined that operating lease accounting shouldn’t be used for long term leases. They issued the bulletin, Disclosure of Long-Term Leases in Financial Statements of Lessors, which required finance leases to be recorded as a leased asset and long-term liability. However, since capitalization was not required by GAAP, most lessees still used off-balance lease reporting.
The Accounting Principles Board issued Reporting of Leases in Financial Statements of Lessees which established that leases should be categorized as finance if the contract has a nominal purchase option.
The Accounting Principles Board issued Accounting for Leases in Financial Statements of Lessors which issued different criteria for finance lease identification than the 1964 opinion.
The SEC asked the FASB to create comprehensive lease accounting rules. They issued FAS 13, Accounting for Leases. This standard has been in place since 1976, though it has been amended multiple times since then.
The Group of Four Plus One (G4 + 1) which includes Australia, Canada, New Zealand, the United Kingdom, and the United States plus the IASB published a discussion paper for a converged standard for lessees which called for the elimination of operating leases.
G4 + 1 began work on a converged standard for lessors building on the 1996 discussion paper.
The Enron Scandal took place causing the SEC to investigate accounting practices that could allow corporate fraud. At this point, the SEC discovered the oﬀ-balance sheet operating lease loophole.
FASB began work on a new lease accounting standard intended to close the loophole of oﬀ-balance operating leases.
The FASB and IASB issued a Discussion Paper proposing that lessees capitalize all leases on the balance sheet.
The FASB and IASB issued an Exposure Draft and distributed it for public comments. The model set forth in the ED proposed that lessees move all leases onto the balance sheet as a right-of-use asset and liability. Lessees, lessors, and the accounting community in general reacted negatively to the ED because they felt the proposal was overly complex and lacked consistency.
After multiple discussions, meetings, and revisions, The FASB and IASB issued a Revised Exposure Draft, and opened a four month comment period. After, the boards solidiﬁed parts of the standard, including that all leases would be brought onto the balance sheet (except short-term leases), expense recognition models, and liability measurement.
The FASB published ASC-842, the new lease accounting standard for companies report- ing under US GAAP. The IASB issued IFRS 16 (eIFRS login required), the new lease ac- counting standard for companies reporting under the International Financial Reporting Standards.
The FASB issued an update to ASC 842 to both clarify and simplify the application of the new lease standard to land easements. The FASB also issued a proposal to ease companies’ transition to the new standard by offering a practical expedient that would allow companies to apply the transition provisions at the adoption date, instead of at the earliest comparative period. The proposal was approved in July of 2018. Also in July, the FASB issued codification improvements affecting narrow aspects of the standard.
The FASB issued codiﬁcation improvements to ASC 842 in March that covered fair value, statements of cash ﬂows, and transition disclosures.
Due to COVID-19 market disruptions, the FASB modiﬁed compliance deadlines for private and select not-for-proﬁt organizations, pushing them out by one year. The earliest deadline is for those whose year-end is December 31 – they will need to transition to the standard by January 1, 2022.

1949

The Committee on Accounting Procedure determined that operating lease accounting shouldn’t be used for long term leases. They issued the bulletin, Disclosure of Long-Term Leases in Financial Statements of Lessors, which required finance leases to be recorded as a leased asset and long-term liability. However, since capitalization was not required by GAAP, most lessees still used off-balance lease reporting.

1964

The Accounting Principles Board issued Reporting of Leases in Financial Statements of Lessees which established that leases should be categorized as finance if the contract has a nominal purchase option.

1966

The Accounting Principles Board issued Accounting for Leases in Financial Statements of Lessors which issued different criteria for finance lease identification than the 1964 opinion.

1976

The SEC asked the FASB to create comprehensive lease accounting rules. They issued FAS 13, Accounting for Leases. This standard has been in place since 1976, though it has been amended multiple times since then.

1996

The Group of Four Plus One (G4 + 1) which includes Australia, Canada, New Zealand, the United Kingdom, and the United States plus the IASB published a discussion paper for a converged standard for lessees which called for the elimination of operating leases.

2000

G4 + 1 began work on a converged standard for lessors building on the 1996 discussion paper.

2001

The Enron Scandal took place causing the SEC to investigate accounting practices that could allow corporate fraud. At this point, the SEC discovered the oﬀ-balance sheet operating lease loophole.

2006

FASB began work on a new lease accounting standard intended to close the loophole of oﬀ-balance operating leases.

2009

The FASB and IASB issued a Discussion Paper proposing that lessees capitalize all leases on the balance sheet.

2010

The FASB and IASB issued an Exposure Draft and distributed it for public comments. The model set forth in the ED proposed that lessees move all leases onto the balance sheet as a right-of-use asset and liability. Lessees, lessors, and the accounting community in general reacted negatively to the ED because they felt the proposal was overly complex and lacked consistency.

2013

After multiple discussions, meetings, and revisions, The FASB and IASB issued a Revised Exposure Draft, and opened a four month comment period. After, the boards solidiﬁed parts of the standard, including that all leases would be brought onto the balance sheet (except short-term leases), expense recognition models, and liability measurement.

2016

The FASB published ASC-842, the new lease accounting standard for companies report- ing under US GAAP. The IASB issued IFRS 16 (eIFRS login required), the new lease ac- counting standard for companies reporting under the International Financial Reporting Standards.

2018

The FASB issued an update to ASC 842 to both clarify and simplify the application of the new lease standard to land easements. The FASB also issued a proposal to ease companies’ transition to the new standard by offering a practical expedient that would allow companies to apply the transition provisions at the adoption date, instead of at the earliest comparative period. The proposal was approved in July of 2018. Also in July, the FASB issued codification improvements affecting narrow aspects of the standard.

2019

The FASB issued codiﬁcation improvements to ASC 842 in March that covered fair value, statements of cash ﬂows, and transition disclosures.

2020

Due to COVID-19 market disruptions, the FASB modiﬁed compliance deadlines for private and select not-for-proﬁt organizations, pushing them out by one year. The earliest deadline is for those whose year-end is December 31 – they will need to transition to the standard by January 1, 2022.