ASC 842 Glossary of Terms

ASC 842, or Accounting Standards Codification Topic 842, is the new lease accounting standard that replaces the previous leases standard, ASC 840. It significantly changes how entities account for leasing arrangements. Below is a glossary of ASC 842-related accounting terms and their definitions to help navigate this complex standard:

Lease: A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.

Lessee: The entity that obtains the right to use an identified asset for a period of time in exchange for consideration.

Lessor: The entity that provides the right to use an identified asset for a period of time in exchange for consideration.

Lease Term: The non-cancellable period for which a lessee has the right to use an underlying asset, including periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option, and periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.

Right-of-Use Asset (ROU): An asset that represents a lessee's right to use an underlying asset for the lease term.

Lease Liability: An obligation to make lease payments arising from a lease, measured on a discounted basis.

Lease Payment: Payments made by a lessee to a lessor for the right to use an underlying asset, including fixed payments, variable lease payments that depend on an index or a rate, amounts expected to be payable under residual value guarantees, the exercise price of a purchase option if the lessee is reasonably certain to exercise that option, and payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease.

Discount Rate: The rate used to discount lease payments to present value in order to measure the lease liability. For lessees, this is typically the rate implicit in the lease or, if that rate cannot be readily determined, the lessee’s incremental borrowing rate.

Incremental Borrowing Rate (IBR): Also called the Relevant Borrowing rate. 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.

Rate Implicit in the Lease: The rate of interest that causes the present value of (a) lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.

Short-term Lease: A lease that, at the commencement date, has a lease term of 12 months or less and does not contain a purchase option that the lessee is reasonably certain to exercise.

Lease Modification: A change to the terms and conditions of a lease that was not part of the original terms and conditions of the lease.

Initial Direct Costs: Incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained, excluding lease incentives.

Lease Incentive: Payments made by a lessor to or on behalf of a lessee, or losses incurred by a lessor as a result of assuming a lessee’s preexisting lease, to incentivize a lessee to sign a lease agreement.

These terms form the foundation of ASC 842 and are essential for understanding and applying the standard to lease contracts.