Understanding ASC 842 with an Example Scenario

The ASC 842 Lease Accounting Standard was introduced by the Financial Accounting Standards Board (FASB) to establish new guidelines for lease accounting. Understanding how to build an ASC 842 Lease Accounting amortization schedule and record ASC 842 Lease Accounting journal entries is crucial for accurately reporting lease transactions. In this blog, we will walk through an ASC 842 Lease Accounting example transaction and guide you on the ASC 842 amortization schedule, how the the income statement and balance sheet are recorded, the ASC 842 journal entries that are created and the ASC 842  Disclosure Reporting data.

ASC 842 LEASE ACCOUNTING EXAMPLE

This example transaction does not take into account many of the more complex and subjective areas of the ASC 842 dealing with subjects such as lease renewal options, contingent rents, residual value guarantees and term option penalties.

Let's consider a hypothetical scenario where your company, ABC Marketing, leases office space for a term of 6 years and transitions to the ASC 842 standard with 4 years remaining on the lease term.

Assumptions

1. A six-year non-cancelable lease term:  72 months
   
   
   
   1. Commencement Date:1/1/2020
   
   
   2. Expiration Date: 12/31/2025
   
   
   3. Transition Date: 1/1/2022
   
   
2. Minimum monthly lease payment:  $5,000
   
   
   
   1. Assuming there are no defined lease options, contingent rental payments or residual value guarantee.
   
   
   2. We are not accruing any interest on prepayments or advances received  before commencement or accrued IDC.
   
   
   3. Rent Payments are made on the first of each month.
   
   
   4. Incremental borrowing rate:  7%
   
   
3. Transitioned to the ASC 842 on 1/1/2022


4. Specified as an Operating Lease

Calculated Amounts

Present Value (PV) of lease payments = $210,873

Total lease payments over the 48 month term = $240,000

ASC 842 Amortization Schedule

Accounting entries under the ASC 842 model would be as follows:

ASC 842 Lease Accounting Journal Entries

End of Period 2022
Cash	$ -	$ 60,000
Gross ROU Asset	$ 210,873	$ -
Lease Liability	$ 60,000	$ 223,374
Rent Expense Implied Interest	$ 12,501	$ -
Rent Expense Implied ROU Amortization	$ 47,458	$ -
ROU Asset Accumulated Amortization	$ -	$ 47,458
End of Period 2023
Cash	$ -	$ 60,000
Lease Liability	$ 60,000	$ 9,176
Rent Expense Implied Interest	$ 9,176	$ -
Rent Expense Implied ROU Amortization	$ 50,783	$ -
ROU Asset Accumulated Amortization	$ -	$ 50,783
End of Period 2024
Cash	$ -	$ 60,000
Lease Liability	$ 60,000	$ 5,638
Rent Expense Implied Interest	$ 5,638	$ -
Rent Expense Implied ROU Amortization	$ 54,485	$ -
ROU Asset Accumulated Amortization	$ -	$ 54,485
End of Period 2025
Cash	$ -	$ 60,000
Gross ROU Asset	$ -	$ 210,873
Lease Liability	$ 60,000	$ 1,813
Rent Expense Implied Interest	$ 1,813	$ -
Rent Expense Implied ROU Amortization	$ 58,146	$ -
ROU Asset Accumulated Amortization	$ 210,873	$ 58,146

ASC 842 Lease Accounting Disclosure Reporting Data

In addition to the reporting changes to the balance sheet and Income Statement identified above, firms should evaluate the impact to;

• Current accounting processes
  
  
  • Lease Accounting system/software
  
  
  • Income tax impact
  
  
  • Financial Ratios
    
    
    
    • Increase in EBITDA
    
    
    • Return on Assets
    
    
    • Debt-to-Equity
    
    
    • Interest Coverage
    
    
    • Operating Margins
    
    
    • Debt covenant compliance
    
    
    • Ability to secure financing
    
    
    • Integrity of lease information
    
    
    • Resources required
  
  

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