ASC 842 Journal Entries
ASC 842 journal entries come in two stages. At commencement, the lessee debits a right-of-use asset and credits a lease liability measured at the present value of the lease payments not yet paid (ASC 842-20-30-1). The right-of-use asset is that liability plus payments made at or before commencement and initial direct costs, less lease incentives received (ASC 842-20-30-5).
After commencement, an operating lease records a single straight-line lease cost (ASC 842-20-25-6). A finance lease recognizes two expenses, interest on the liability and amortization of the asset (ASC 842-20-25-5(a)).
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 part of the ROU asset (ASC 842-20-30-5(b)), not the lease liability, which covers only payments not yet paid (ASC 842-20-30-1).
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. An operating lease recognizes a single lease cost (ASC 842-20-25-6). Separate interest expense on the lease liability applies to finance leases only (ASC 842-20-25-5(a)).
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 has no amortization schedule of its own. It is measured from the lease liability (ASC 842-20-35-3(b)), so each period it falls by the difference between the straight-line cost and the interest accreted on the liability.
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. For operating and finance leases alike, the lessee removes the ROU asset and the lease liability and recognizes the difference in profit or loss (ASC 842-20-40-1).
Variable Payment Real Estate Tax: Payments for real estate taxes that vary based on assessment changes, expensed as incurred for operating and finance leases alike (ASC 842-20-25-5(b), 842-20-25-6(b)). Only variable payments that depend on an index or a rate enter the lease liability (ASC 842-10-30-5(b)), and KPMG's Handbook: Leases (¶5.4.115) notes a property tax mill rate is not one.
Variable Payment Insurance Expense: Insurance costs associated with leased assets, expensed when incurred, or included in the lease liability if they depend on an index or a rate, whatever the classification (ASC 842-10-30-5(b)).
Variable Payment Sales Tax: Sales taxes on lease payments. They are not automatically lease payments. KPMG's Handbook: Leases (Question 4.2.60) ties the lessee's accounting to who is the primary obligor, lessee or lessor, and when the tax is incurred. A tax incurred over the lease term stays out of the ROU asset either way.
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 | The lease liability, plus prepayments and initial direct costs, less incentives received (ASC 842-20-30-5) | |
| Lease liability | Present value of the lease payments not yet paid |
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.
Capital lease journal entries: the ASC 842 finance lease
"Capital lease" is ASC 840 vocabulary. Under ASC 842 the lessee term is finance lease, and the entries follow the finance column above. The liability accretes interest at a constant periodic rate and is reduced by each payment (ASC 842-20-35-1). The right-of-use asset is amortized straight-line unless another systematic basis is more representative (ASC 842-20-35-7).
KPMG's Handbook: Leases (paragraph 6.4.140) calls that amortization and accretion guidance "substantially the same" as for ASC 840 capital leases. The differences KPMG lists are in the subsequent accounting: monitoring for reassessment events, remeasuring the liability and right-of-use asset when one occurs, and accounting for modifications.
Take a three-year equipment finance lease: $10,000 paid at the end of each year and a 5% discount rate. Nothing is paid at commencement, there are no initial direct costs or incentives, and the useful life is longer than the term. With no transfer of ownership or purchase option the lessee is reasonably certain to exercise, the asset is amortized over the three-year term (ASC 842-20-35-8).
The liability is the present value of all three payments, $27,232.48, and the right-of-use asset is debited the same amount. Year one's entries:
| Account | Debit | Credit |
|---|---|---|
| Interest expense ($27,232.48 × 5%) | $1,361.62 | |
| Lease liability | $8,638.38 | |
| Cash | $10,000.00 | |
| Amortization expense ($27,232.48 ÷ 3) | $9,077.49 | |
| Accumulated amortization, right-of-use asset | $9,077.49 |
Year-one expense is $10,439.11, more than the cash paid. The liability closes at $18,594.10, so year-two interest drops to $929.71.
Subleases
Under ASC 842, a sublease is classified by reference to the underlying asset, not the right-of-use asset (ASC 842-10-25-6). A sales-type or direct financing sublease derecognizes the head-lease right-of-use asset (ASC 842-20-35-14(b) and (c)).
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 on the balance sheet, and an operating sublease does not take the head lease off the books — which is the error most often made.
KPMG's Handbook: Leases describes sublease classification and sublease income recognition as "effectively unchanged from Topic 840" (¶8.2.130). The change is on the head lease. An operating head lease stayed off the balance sheet under ASC 840; under ASC 842 its right-of-use asset and lease liability sit alongside the sublease (¶8.2.150).
Worked example: a 24-month operating sublease with stepped rent
On an operating sublease, the sublessor recognizes sublease income straight-line over the sublease term (ASC 842-30-25-11(a)). Initial direct costs are expensed over the term on the same basis (ASC 842-30-25-11(c)).
Say you sublet a floor for 24 months at $4,000 a month in year one and $4,200 in year two, with no free rent or initial direct costs. Total rent is $98,400, so income is $4,100 every month. In month one, debit cash $4,000 and a straight-line rent receivable $100, and credit sublease income $4,100. From month 13, cash exceeds income by $100 and the receivable unwinds to zero by month 24.
On an operating sublease, the head-lease entries do not change (ASC 842-20-35-14(a)). If the head-lease cost over the sublease term exceeds the sublease income you expect, ASC 842-20-35-14(a) treats that as an indicator the right-of-use asset may not be recoverable.
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.
Get the Best ASC 842 Software Solution from iLeasePro
At iLeasePro, we've been helping companies understand and implement ASC 842 since it replaced ASC 840 for private companies in 2021. We know the standard inside out, and we know how to implement software solutions that will help you be in compliance.
We've done this for both small and large businesses, and we've also helped these companies use ASC 842 as a business tool to operate more efficiently, get better reporting and use their leases as assets. When you call us we can set you up with a lease accounting software free demo so you can see how it all works.
To do this, call us at 888-351-4606, or you can email us at info@ileasepro.com. We also have plenty of great information about lease accounting software on our website at iLeasePro, and you can chat with a live representative there as well.
Frequently asked questions
- Can sublease income be netted against the head lease cost?
- Not on the balance sheet: KPMG's Handbook: Leases (Question 8.2.50) says that while the sublessor is not relieved of its primary obligation, netting the head lease and sublease there is "never appropriate." KPMG notes ASC 842 has no explicit income-statement rule and accepts either of two approaches. One is "gross presentation in all cases." The other treats net presentation as "acceptable, but not required," where subleasing is not a significant business activity and is used to manage occupancy costs.