Calculating Rent Expense Under the ASC 842. Use 365 day or 360 day basis?
ASC 842 Rent Expense Calculation
The ASC 842 Lease Accounting
Standard, implemented by the Financial Accounting Standards Board (FASB), brought about significant changes to how
companies recognize, measure, and present lease transactions in their financial statements. One of the critical aspects
of lease accounting is determining the accurate expense associated with a lease, especially for operating
leases.
iLeasePro calculates on a 365-day basis and here is why calculating
rent expense on a 365-day basis is more accurate than on a 360-day basis under ASC 842:
1. Real-world
Basis: There are 365 days in a standard year (and 366 days in a leap year). When you calculate the rent
expense on a 365-day basis, you're aligning your financial calculations with the actual number of days in a year. Using
a 360-day basis, on the other hand, would mean you're understating the daily rent expense, leading to potential
inaccuracies in financial reporting.
2. Consistency with Other Accounting Standards: ASC 842
aims to provide a consistent approach to lease accounting. Other areas of accounting, like interest calculations for
certain types of debt, may also use a 365-day basis. By using a consistent approach, companies can reduce complexity and
potential errors in their financial calculations.
3. Precision in Monthly Allocations: Some
months have 30 days, while others have 31 days (and February can have 28 or 29). If you use a 360-day basis, you're
assuming each month has 30 days, which can distort the monthly allocation of rent expense. On a 365-day basis, you can
more accurately allocate the expense based on the actual number of days in each month. This gets very tricky and
difficult to prorate when you have a lease that starts mid-month.
4. Fair Representation in Financial
Statements: ASC 842 emphasizes the importance of transparency and providing a fair view of a company's
financial position and performance. By using a 365-day basis, companies ensure that their reported lease expenses truly
represent their obligations, leading to more informed decisions by stakeholders.
5. Avoidance of
Complications in Long-term Leases: For longer-term leases, using a 360-day year can lead to significant
discrepancies between the recognized expense and the actual cash outflows. Over several years, these discrepancies can
compound, making financial statements less reflective of economic reality.
6. Adherence to the Principle
of Conservatism: In accounting, when given a choice between two valid methods, it's often recommended to
choose the one that's less likely to overstate assets or understate liabilities. By calculating rent on a 365-day basis,
companies might end up recognizing a slightly higher expense than on a 360-day basis, adhering to the principle of
conservatism.
In conclusion, while a 360-day basis might seem simpler or more convenient, it does not accurately
represent the economic realities of a lease under ASC 842. By using a 365-day basis as used by iLeasePro, companies can
provide a clearer, more accurate picture of their financial position and performance, aligning with the primary
objectives of the ASC 842 standard.
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