Medical Practice Lease Accounting: Office Suites, Equipment and Owner Buildings
A medical practice accounts for leases under ASC 842 like any other private company. The practice records a right-of-use (ROU) asset and a lease liability for its office suite and for most clinical equipment leases. What sets medical practice lease accounting apart is the mix: a build-out funded by the landlord, equipment with a $1 buyout, and often a building the doctors own themselves.
This page is for the controller or outside accountant at an independent physician, dental or eye care practice. For the wider picture across hospitals and health systems, start with healthcare lease accounting under ASC 842.
Which leases does an independent practice usually carry?
ASC 842 has no size exemption. A practice that issues US GAAP financial statements applies it. Private companies adopted it for fiscal years beginning after December 15, 2021, under the transition guidance in ASC 842-10-65-1.
Most practices hold three kinds of arrangement:
- The office or suite lease, often in a medical office building or a retail strip.
- Clinical equipment: dental chairs and imaging, lasers, diagnostic devices.
- A building rented from a real estate entity that the physicians own.
Each one lands on the balance sheet differently. The sections below take them in that order. A worked example then puts numbers on the first two.
How do you measure the office suite lease?
At commencement, the lease liability is the present value of the lease payments not yet paid (ASC 842-20-30-1(a)). Rent paid on day one is left out of the liability and added to the ROU asset instead (ASC 842-20-30-5(b)). The discount rate is the first decision.
A practice that is not a public business entity can elect a risk-free rate under ASC 842-20-30-3. The election applies when the rate implicit in the lease is not readily determinable, and it is made by class of underlying asset. The risk-free rate uses a period comparable to the lease term. A lower rate gives a larger liability, a trade-off covered in the ASC 842 risk-free rate election.
Short arrangements can stay off the balance sheet. ASC 842-20-25-2 lets a lessee elect, by class of asset, not to recognize short-term leases. A short-term lease has a term of 12 months or less and no purchase option the lessee is reasonably certain to exercise. The rent on an exempt lease is then expensed straight-line, and ASC 842 short-term leases covers the edge cases.
Is dental office lease accounting under ASC 842 any different?
The rules are the same as for any office suite. In a dental suite, the question that most often moves the numbers is the build-out, and who owns it. As an illustration, suppose the landlord funds plumbing and cabinetry for each operatory through a tenant improvement allowance.
If the practice owns those improvements, the allowance is a lease incentive (see Deloitte Roadmap: Leases, section 8.8.3 on which party owns the improvements). Under ASC 842-20-30-5(b), incentives received at or before commencement reduce the ROU asset. An allowance still payable reduces the lease payments in the liability instead (ASC 842-10-30-5(a)). The practice capitalizes the improvements as its own leasehold improvements.
If the landlord owns the improvements, they are the landlord's asset, not the practice's leasehold improvements. The tenant improvement allowance accounting page covers how to decide who owns what. Dental chairs and imaging units follow the equipment rules in the next section.
How are eye-care practice equipment leases classified?
Eye care practice equipment leases, for lasers, imaging and other diagnostic devices, often end with a $1 or other nominal purchase option. ASC 842-10-25-2(b) makes a lease a finance lease when the lessee is reasonably certain to exercise a purchase option.
A $1 option on equipment the practice will still be using is usually a strong economic incentive to buy, so it will often be reasonably certain of exercise. That is still a judgment made at commencement, not a rule (PwC Viewpoint, Leases guide, section 3.3.2).
A finance lease puts two charges on the income statement. ASC 842-20-25-5 requires amortization of the ROU asset and interest on the lease liability. When a purchase option is reasonably certain, ASC 842-20-35-8 amortizes the ROU asset over the equipment's useful life, not the lease term.
Watch for equipment placed "free" with a supply or consumables agreement. The device may be an embedded lease under the definition in ASC 842-10-15-3. For how to spot one, see healthcare embedded leases. For the full classification walkthrough, see the medical equipment lease classification guide.
What do the suite and the equipment look like in numbers?
Take one practice with one suite lease and one equipment lease. Both start on the same day. The inputs are illustrative, not market quotes.
- Suite lease (operating). 60 months. Rent is $12,000 a month in year 1 and rises 3% each year. Rent is paid monthly in advance, on the first of the month, starting at commencement. The landlord pays a $60,000 allowance at commencement for improvements the practice owns. The practice elects the risk-free rate for real estate and uses 4.00% a year, compounded monthly.
- Equipment lease (finance). An imaging device on 60 monthly payments of $1,800, paid in arrears, at month-end. A $1 purchase option is due at the end of month 60. The practice cannot readily determine the implicit rate. It has not made the risk-free election for equipment, so it uses an incremental borrowing rate of 7.00% a year, compounded monthly. The device's useful life is 7 years. The practice expects to keep using it and concludes at commencement that exercise of the $1 option is reasonably certain. That conclusion is what makes the lease a finance lease.
Suite rent each year is $12,000 × 1.03^(year − 1), rounded to the cent. By year, that is $12,000.00, $12,360.00, $12,730.80, $13,112.72 and $13,506.11 a month. Total rent over 60 months is $764,515.56.
| Item | Suite lease (operating) | Equipment lease (finance) |
|---|---|---|
| Payment timing | Monthly in advance | Monthly in arrears |
| Discount rate | 4.00% risk-free | 7.00% incremental borrowing rate |
| Opening lease liability | $680,544.59 | $90,904.29 |
| Plus rent paid at commencement | $12,000.00 | None |
| Less incentive received | ($60,000.00) | None |
| Opening ROU asset | $632,544.59 | $90,904.29 |
| Year 1 cash paid | $144,000.00 | $21,600.00 |
| Year 1 interest | Not shown separately | $5,864.83 |
| Year 1 ROU amortization | Not shown separately | $12,986.33 (over 84 months) |
| Year 1 expense | $140,903.11 single lease cost | $18,851.16 total |
| Lease liability, end of year 1 | $573,601.47 | $75,169.12 |
| ROU asset, end of year 1 | $516,698.36 | $77,917.96 |
Here is how the suite figures tie out. The straight-line cost is total rent of $764,515.56, less the $60,000 allowance, spread over 5 years. That gives $140,903.11 a year, recognized as a single lease cost under ASC 842-20-25-6.
Within that cost, $25,056.88 is liability accretion and $115,846.23 reduces the ROU asset. The escalator alone would put cost above cash, but the $60,000 allowance, spread over five years, brings it below.
The equipment liability includes the $1 option, discounted from month 60, because ASC 842-10-30-5 counts an option price the lessee is reasonably certain to pay. The ROU asset is amortized over 84 months, the useful life, under ASC 842-20-35-8. That is $90,904.29 divided by 7, or $12,986.33 a year. Interest is front-loaded, so year 1 carries the heaviest total cost.
The day-one entries follow ASC 842-20-30-1 and 842-20-30-5(b):
- Suite. Debit ROU asset $632,544.59 and debit cash $60,000.00 for the allowance received. Credit lease liability $680,544.59 and credit cash $12,000.00 for the first month's rent.
- Equipment. Debit ROU asset $90,904.29. Credit lease liability $90,904.29.
How do you account for a physician-owned building lease?
Many practices rent from a real estate limited liability company (LLC) that the same physicians own. That is a related party lease, and it is still a lease.
ASC 842-10-55-12 classifies it on its legally enforceable terms. The FASB's basis for conclusions (ASU 2016-02, BC374) adds that the accounting is not adjusted for economic substance. A handshake rent that floats with the practice's cash flow makes those terms hard to pin down.
A private company may use the written terms of an arrangement with an entity under common control (ASC 842-10-15-3A, added by ASU 2023-01). It uses them to decide whether the arrangement is a lease and, if it is, to classify and account for it. It applies arrangement by arrangement, and only where written terms exist. The related party leases page covers the rest.
What happens to the leases when a dental service organization or health system buys the practice?
When a dental service organization, a health system or a private equity platform acquires the practice, the buyer recognizes its leases under ASC 805-20-25-28A. ASC 805-20-30-24 measures each lease liability as if the lease were new on the acquisition date. The buyer keeps the practice's classification, with one exception (ASC 805-20-25-8(a) and ASC 842-10-55-11). The exception is a lease modified as part of the deal, where that modification is not accounted for as a separate contract.
For the seller's controller, a clean lease schedule makes diligence faster. The buyer needs each lease's terms, payments, options and dates to remeasure it, and a complete schedule hands those over in one file. See ASC 805 business combinations and lease accounting for the buyer's side.
Frequently asked questions
Does a small medical practice have to follow ASC 842?
Yes, if it issues financial statements under US GAAP. ASC 842 has no size exemption. Private companies applied it for fiscal years beginning after December 15, 2021, under ASC 842-10-65-1.
Is dental equipment with a $1 buyout a finance lease?
Usually. A $1 option is a strong incentive to buy, so the practice will often be reasonably certain to exercise it, which meets ASC 842-10-25-2(b). When it is, the lease is a finance lease, and the right-of-use asset is amortized over the equipment's useful life.
What happens to a practice's leases when it is acquired?
The buyer measures each lease liability as if the lease were new on the acquisition date, under ASC 805-20-30-24. The buyer keeps the practice's classification, with one exception (ASC 805-20-25-8(a) and ASC 842-10-55-11). The exception is a lease modified as part of the deal, where that modification is not accounted for as a separate contract.
Sources and further reading
- ASC 842-10-15-3 and 842-10-15-3A — the definition of a lease and the common-control written-terms practical expedient (ASU 2023-01).
- ASC 842-10-25-2 — lease classification criteria, including the purchase option in (b).
- ASC 842-10-30-5 — lease payments, including a purchase option price the lessee is reasonably certain to pay.
- ASC 842-10-55-11 — a lease acquired in a business combination keeps its classification unless modified and not accounted for as a separate contract.
- ASC 842-10-55-12 — related party leases classified on legally enforceable terms; ASU 2016-02, BC374, on economic substance.
- ASC 842-10-65-1 — effective dates and transition.
- ASC 842-20-25-2 — the short-term lease recognition exemption.
- ASC 842-20-25-5, 842-20-25-6 and 842-20-35-8 — finance and operating lease cost, and the ROU amortization period.
- ASC 842-20-30-1, 842-20-30-3 and 842-20-30-5 — initial measurement of the lease liability, the risk-free rate election and initial measurement of the ROU asset.
- ASC 805-20-25-8(a), 805-20-25-28A and 805-20-30-24 — classification and measurement of leases acquired in a business combination.
- PwC Viewpoint, Leases guide, section 3.3.2 — purchase options and the reasonably certain judgment.
- Deloitte Roadmap: Leases, section 8.8.3 — which party owns leasehold improvements.
- KPMG Handbook: Leases — sections 5.6 and 6.3 on discount rates and initial measurement, and section 6.4 on ROU amortization.
- Deloitte Roadmap: Leases, section 7.2, Determination of the Discount Rate for Lessees.
- Deloitte Roadmap: Leases, section 8.3, Lease Classification.
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