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ASC 842 Journal Entries
The transition from ASC 840 to ASC 842 has introduced a comprehensive overhaul of lease accounting practices for both lessees and lessors. This change aims to increase transparency and comparability among organizations by requiring lessees to recognize right-of-use (ROU) assets and lease liabilities on their balance sheets for virtually all leases.
Understanding the terminology and journal entries associated with ASC 842 is crucial for accurately applying these new standards and ensuring compliance. This guide focuses specifically on journal entries, but for a comprehensive overview of the entire standard, see our ASC 842 Complete Guide. Below, we delve into key terms and definitions, including those carried over or adapted from ASC 840 for comparative understanding.
This glossary facilitates a deeper comprehension of the ASC 842 lease accounting framework and underscores the impact of these changes on financial statements. Additionally, we incorporate the concept of cash flows, pivotal in reflecting the actual financial transactions between lessees and lessors, thus offering a holistic view of the accounting treatment under the new lease accounting standard.
Cash: Cash movements are integral to lease accounting transactions, reflecting the payment and receipt of funds related to leasing activities. Key journal entries involving cash in lease accounting under ASC 842 include:
- Lease Payments: Decreases in cash for lease payments made by the lessee to the lessor, impacting the lease liability and, for finance leases, interest expense.
- Initial Direct Costs: Outflows of cash for costs directly attributable to obtaining a lease, which are capitalized and included in the ROU asset.
- Sublease Payments Received: Increases in cash for payments received from sublessees, recognized as sublease income by the original lessee.
- Variable Lease Payments: Cash outflows for variable lease payments not included in the lease liability measurement but recognized as expenses in the period incurred.
- Lease Incentives Received: Cash inflows from lessors as lease incentives, reducing the ROU asset.
Non-Lease Expenses: Expenses related to the leased asset that do not fall under lease accounting, such as maintenance and utilities, which are recognized as incurred.
Short-Term Lease Expense: Expense recognized for leases with a term of 12 months or less that do not contain a purchase option the lessee is reasonably certain to exercise. Lessees may elect not to recognize ROU assets and liabilities for these leases, recognizing lease payments as expense on a straight-line basis over the lease term.
Operating Accrued Rent Liability: Under ASC 840, this represented the liability for rent expense incurred but not yet paid. Under ASC 842, this concept is replaced by the lease liability and ROU asset model.
Operating Prepaid Rent Asset: Previously recognized for rent payments made in advance of the lease term. Under ASC 842, advance payments are considered in the measurement of the lease liability and ROU asset.
Operating Straight-line Rent Liability: A liability recognized under ASC 840 to account for the difference between cash rent payments and the recognition of rent expense on a straight-line basis. ASC 842 eliminates this approach for operating lease expense recognition, favoring a model that recognizes a lease liability and ROU asset amortization.
Capital Lease Gross ROU Asset: Under ASC 840, this was referred to as a capital lease and recognized on the balance sheet. ASC 842 changes the terminology to finance lease and still recognizes the ROU asset and lease liability on the balance sheet.
Capital Lease Asset Accumulated Amortization: Amortization of the leased asset under a capital lease. Under ASC 842, this is referred to as finance lease ROU asset amortization.
Capital Lease Liability: The liability for a capital lease, reflecting future lease payments. Under ASC 842, this is termed a finance lease liability.
Operating Accrued IDC Liability: Not a specific term under ASC 842. Initial direct costs (IDCs) are capitalized and included in the ROU asset for both operating and finance leases, not recognized as a separate liability.
Operating Deferred Lease Incentive Liability: Represents lease incentives provided by the lessor, which reduce the ROU asset for an operating lease.
Operating Gross ROU Asset: The ROU asset recognized at lease commencement, representing the lessee’s right to use the underlying asset for an operating lease.
Operating Initial Direct Cost Asset: Costs directly attributable to obtaining a lease that are included in the ROU asset for operating leases.
Operating Lease Liability: The liability recognized at lease commencement, representing the present value of lease payments for an operating lease.
Operating Prepaid Lease Asset: Prepayments made to the lessor before the lease term begins, included in the measurement of the ROU asset for operating leases.
Operating Rent Expense: Implied Interest: Not a standard term under ASC 842. Operating lease expenses are recognized as a single lease cost, combining asset amortization and interest on the lease liability for finance leases, not operating leases.
Operating Rent Expense: Implied ROU Amortization: This concept does not exist under ASC 842 as described. Operating lease cost is recognized on a straight-line basis over the lease term, which implicitly includes amortization of the ROU asset.
Operating ROU Asset Accumulated Amortization: Under ASC 842, the operating lease ROU asset is not amortized separately; instead, the lease cost is recognized on a straight-line basis.
Finance Accrued IDC Liability: Not a specific term under ASC 842. For finance leases, initial direct costs are included in the ROU asset.
Finance Deferred Lease Incentive Liability: Represents lease incentives under a finance lease, which reduce the ROU asset.
Finance Gross ROU Asset: The ROU asset for a finance lease, representing the right to use the leased asset.
Finance Initial Direct Cost Asset: Costs directly attributable to obtaining a finance lease included in the ROU asset.
Finance Lease Liability: The liability for a finance lease, reflecting the present value of future lease payments.
Finance Prepaid Lease Asset: Prepayments for a finance lease, included in the ROU asset measurement.
Finance Interest Expense: Interest expense recognized on the finance lease liability, representing the cost of borrowing over the lease term.
Finance ROU Asset Amortization Expense: The systematic charge to expense of the finance lease ROU asset over the lease term, reflecting the consumption of the asset's economic benefits.
Finance ROU Asset Accumulated Amortization: The total amount of the finance ROU asset that has been amortized up to a specific date.
Finance Owned Gross Asset: Not directly applicable under ASC 842. This term might refer to assets owned by the entity that are not leased, with their cost recognized on the balance sheet.
Finance Owned Asset Accumulated Depreciation: Accumulated depreciation on assets owned by the entity, reflecting the consumption of their economic benefits over time.
Early Termination Gain/Loss: Gains or losses recognized when a lease is terminated before the end of its term, calculated as the difference between any termination penalty and the remaining lease liability balance for finance leases or the write-off of the ROU asset for operating leases.
Variable Payment Real Estate Tax: Payments for real estate taxes that vary based on assessment changes, recognized as expenses in the period incurred for operating leases or included in the measurement of the lease liability for finance leases if linked to an index or rate.
Variable Payment Insurance Expense: Insurance costs associated with leased assets, recognized as expenses when incurred for operating leases or included in the finance lease liability measurement if they depend on an index or rate.
Variable Payment Sales Tax: Sales taxes on lease payments, treated as part of the lease payments for both operating and finance leases, affecting the lease liability and ROU asset measurement.
Variable Payment Other Expense: Other variable lease payments not included in the initial measurement of the lease liability but recognized as expenses in the period incurred for operating leases or when the obligation for those payments is incurred for finance leases.
Accounts Receivable: Represents amounts due from lessees under sublease arrangements or other receivables related to lease agreements.
Sublease Account Receivable: Amounts due from sublessees, recognized by the original lessee who becomes a lessor in a sublease arrangement.
Sublease Initial Direct Cost Expense: Direct costs associated with negotiating and arranging a sublease, typically recognized over the sublease term as part of the sublease income recognition.
Sublease Deferred Direct Cost Expense: Not a specific term under ASC 842. Initial direct costs in a sublease are included in the net investment in the sublease or expensed as incurred, depending on the lease classification.
Sublease Direct Cost Expense: Expenses directly attributable to obtaining a sublease, recognized over the term of the sublease or as incurred.
Sublease Income: Income recognized by the original lessee from subleasing the leased asset to a third party, presented over the term of the sublease.
The Entries Themselves
The terminology above is the vocabulary; these are the entries it describes. Both lease types start in the same place and diverge immediately afterwards.
At commencement — identical for both
| Account | Debit | Credit |
|---|---|---|
| Right-of-use asset | Present value of the lease payments, plus prepayments and initial direct costs, less incentives | |
| Lease liability | Present value of the lease payments |
Whether the lease is finance or operating makes no difference on day one — the classification decides what happens in every period after it. How the right-of-use asset is built is set out in calculating the ROU asset.
Each period afterwards — where they diverge
| Operating lease | Finance lease | |
|---|---|---|
| What is recognized | A single straight-line lease cost | Interest on the liability and amortization of the asset, separately |
| Debits | Lease expense | Interest expense; amortization expense |
| Credits | Cash for the payment; the right-of-use asset for the balancing amortization | Cash for the payment; accumulated amortization on the asset |
| Lease liability | Debited by the payment, credited by the interest accreted | Debited by the payment, credited by the interest accreted |
| Expense shape over the term | Flat | Front-loaded — interest is largest at the start |
The operating-lease amortization of the right-of-use asset is not calculated on its own. It is the difference between the straight-line cost and the interest accreting on the liability, which is exactly what keeps total expense flat. A full side-by-side with worked figures is in operating versus finance lease entries compared, and journal entries explained with examples works through a complete lease.
Subleases
A sublease is two arrangements, not one. You remain the lessee on the head lease and keep recognizing it, and you become the lessor on the sublease and account for that separately. The two are not netted, and the head lease is not derecognised simply because someone else is now occupying the asset — which is the error most often made.
Which classification applies
Everything above depends on the finance-versus-operating answer, and that is not a choice. It follows from five criteria in ASC 842-10-25-2, any one of which is enough to make a lease a finance lease — set out in ASC 842 lease classification. If your entries look wrong, the classification is the first thing to re-check; common lease journal entry errors covers what usually goes wrong after that.
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