ASC 842 Short-Term Leases

ASC 842 Short-Term Leases

An ASC 842 short-term lease has a lease term of 12 months or less at the commencement date and no purchase option the lessee is reasonably certain to exercise (ASC 842 glossary). A lessee can elect, by class of underlying asset, to keep these leases off the balance sheet and expense the payments straight-line (ASC 842-20-25-2).

Our guide to ASC 842 practical expedients covers the full set.

In the world of accounting and finance, understanding the nuances of lease accounting is crucial for businesses and accounting professionals. The introduction of the ASC 842 lease accounting standard has significantly changed how entities recognize, measure, present, and disclose leases.

This article focuses on short-term leases under ASC 842, highlighting how they are defined, the accounting treatments they undergo, and how they differ from operating and finance leases. Short-term leases receive special treatment under ASC 842. This focused guide covers short-term lease accounting, while our ASC 842 Complete Guide addresses all lease types and requirements. Additionally, we'll walk through an example of journal entries for a short-term lease to provide practical insight into the topic.

Short-Term Lease Accounting

The accounting treatment for short-term leases under ASC 842 is designed to simplify the accounting process for leases that meet the short-term criteria. For lessees, short-term leases offer a practical expedient that allows them not to recognize lease assets and lease liabilities on the balance sheet.

Instead, lessees can recognize lease payments associated with short-term leases as an expense on a straight-line basis over the lease term, similar to the accounting treatment of operating expenses.

This approach significantly reduces the complexity and administrative burden of lease accounting for short-term leases.

It's important to note, however, that this practical expedient is optional. Lessees must elect to apply it by class of underlying asset, and once elected, the lessee must apply the expedient to all short-term leases of that asset class.

Short-Term, Operating, and Finance Leases

The distinctions between short-term leases and the two main types of leases under ASC 842, operating and finance leases, are primarily based on the lease term and the recognition of lease assets and liabilities.

Operating Leases: Typically involve longer lease terms and result in the recognition of a right-of-use asset and a lease liability on the balance sheet. The lessee recognizes a single lease cost, generally on a straight-line basis over the lease term (ASC 842-20-25-6(a)).

Finance Leases: Like operating leases, finance leases involve longer lease terms but meet at least one of the five classification criteria in ASC 842-10-25-2. They result in a front-loaded expense pattern, where interest expense decreases over the lease term as lease payments are made.

In contrast, short-term leases under ASC 842 are not recorded on the balance sheet (if the practical expedient is elected). Lease payments are expensed straight-line over the lease term (variable payments as incurred) (ASC 842-20-25-2). This key difference simplifies the accounting process and reduces the reporting burden for entities with numerous short-term leases.

Journal Entry Example for a Short-Term Lease

With the election made, a short-term lease needs no entry to recognize an asset or liability at commencement. Each month you debit lease expense for the straight-line amount (ASC 842-20-25-2) and credit cash or accounts payable. If payments are uneven, the timing difference between expense and cash sits in accrued or prepaid rent. Leases on the balance sheet take more entries, shown in our ASC 842 journal entries with examples.

To illustrate the accounting treatment of short-term leases, let's consider a simple example. Assume a company enters into a 12-month office space lease with monthly payments of $1,000, and the company elects the practical expedient for short-term leases.

Journal Entry for Lease Payments:

This entry would be made each month throughout the lease term. The company recognizes the lease payments as an expense directly in the income statement, without recognizing any lease assets or liabilities on the balance sheet.

Do Month-to-Month Leases Qualify?

A month-to-month lease is not automatically short-term. It qualifies only if its ASC 842 lease term, not the billing cycle, is 12 months or less. The lease term is the noncancellable period plus certain optional periods (ASC 842-10-30-1). Those are renewals the lessee is reasonably certain to exercise, termination options it is reasonably certain not to exercise, and any renewal or non-termination period the lessor controls.

A lease stops being enforceable once both lessee and lessor can terminate without the other's permission and with no more than an insignificant penalty (ASC 842-10-55-23).

This is the case that comes up most and the one the twelve-month rule answers least cleanly. A month-to-month arrangement looks like a one-month lease, and on that reading every one of them qualifies for the exemption. That reading does not always hold.

The test is not the billing cycle, it is the ASC 842 lease term — the noncancellable period plus the optional periods listed above (ASC 842-10-30-1). A rolling monthly arrangement you have occupied for six years, hold the fit-out in, and have no intention of leaving is not obviously a one-month lease, whatever the invoice says.

Two questions decide it. What period is actually enforceable — if both parties can walk away with a month's notice and no more than an insignificant penalty, the enforceable period may genuinely be one month (ASC 842-10-55-23).

And is continuation reasonably certain, judged on the economics rather than intent: the cost of moving, leasehold improvements you would abandon, whether an equivalent asset is even available. A long-standing month-to-month with high switching costs is the classic case of a lease that fails the exemption despite its label.

The Renewal Option That Disqualifies

The same mechanism catches fixed-term leases. A twelve-month lease with a twelve-month renewal you are reasonably certain to exercise has an ASC 842 lease term of twenty-four months, and does not qualify for the exemption — even though the contract on your desk says one year.

So the exemption is not decided by reading the term off the front page. It is decided after assessing options, which is the same assessment that drives measurement for every other lease.

Where that assessment changes later, the lease stops being short-term if the remaining term now runs more than 12 months past the end of the previously determined term (ASC 842-20-25-3). A purchase option that becomes reasonably certain has the same effect. The lease then comes onto the balance sheet as if the date of the change were the commencement date. That change is one of the events that trigger remeasurement.

The practical consequence is that the exemption saves less work than it appears to. You still have to identify the population, establish each lease term, and reassess when circumstances change — the saving is recognition, not analysis. That is worth knowing before electing it across an asset class on the assumption that those leases can then be ignored.

The Bottom Line

ASC 842 has introduced significant changes to lease accounting, aiming to enhance transparency and comparability. Short-term leases under ASC 842 offer a simplified accounting treatment that can ease the administrative burden for businesses.

By understanding the definition, accounting treatment, and differences between short-term, operating, and finance leases, entities can better navigate the complexities of lease accounting and ensure compliance with the standard.

The practical example provided illustrates how straightforward the accounting for short-term leases can be once the election is made for eligible leases.