ASC 842 and Sale-Leasebacks: Accounting, Journal Entries, and Key Risks

Lease accounting has never been simple, and the adoption of ASC 842 brought it front and center for executives and auditors alike. Nearly all leases now appear on the balance sheet as right-of-use (ROU) assets and lease liabilities, making sale-leasebacks much more transparent—and more complex.

When a company sells property and leases it back, it moves from reporting the property as PP&E (property, plant, and equipment) to being a lessee under ASC 842. This shift doesn’t change the economics of the transaction, but it does change how results are reported, how ratios move, and how investors interpret financial health.

Lease Classification Under ASC 842

ASC 842 requires leases to be classified as either:

• Finance Lease — Recognized with interest expense on the lease liability and amortization expense on the ROU asset.
• Operating Lease — Recognized as a single straight-line lease expense over the term.

The classification is determined by criteria such as whether ownership transfers, whether a bargain purchase option exists, or whether the lease term covers most of the asset’s useful life.

Real-World Example: A Healthcare Provider Sale-Leaseback

A regional healthcare provider owns its headquarters, valued at $20 million. To unlock capital for expansion, it sells the property to an investor and immediately leases it back for 15 years.

• Sale price: $20 million
• Lease term: 15 years
• Present value of lease payments: $15 million
• Classification under ASC 842: Finance Lease (since the lease term covers most of the asset’s useful life).

Journal Entries

Step 1: Record the Sale

Dr. Cash                                   20,000,000
    Cr. Building (PP&E)                               20,000,000

(If the book value was less than $20M, a gain would also be recognized. For simplicity, assume book value = $20M, so no gain/loss.)

Step 2: Record Leaseback (Finance Lease Recognition)

Dr. Right-of-Use Asset                     15,000,000
    Cr. Lease Liability                                 15,000,000

Step 3: First Lease Payment

Assume annual payments are $1.5 million, with the first payment due immediately. Under ASC 842, the payment is split between interest expense (on the liability) and reduction of principal. Let’s assume the first year’s interest portion is $600,000 and the principal reduction is $900,000.

Dr. Interest Expense                          600,000
Dr. Lease Liability                            900,000
    Cr. Cash                                               1,500,000

Step 4: Amortize the ROU Asset

For a finance lease, the ROU asset is amortized over the lease term.
Annual amortization = $15,000,000 ÷ 15 years = $1,000,000.

Dr. Amortization Expense                   1,000,000
    Cr. Accumulated Amortization (ROU Asset)           1,000,000

Why This Matters

• Balance Sheet: $15M lease liability and $15M right-of-use asset.
• Income Statement: Interest expense ($600K) + amortization expense ($1M), instead of smooth rent expense.
• Ratios: Higher leverage due to recognition of lease liability.
• Investor Optics: A debt-like obligation appears, even though economically the company just sold an asset and leased it back.

Risks to Consider

• Balance Sheet Leverage — Lease liabilities inflate reported debt, potentially worsening leverage ratios and affecting access to credit.
• Earnings Volatility — Variable lease payments tied to CPI or other metrics flow directly through the P&L, creating unpredictable swings.
• Covenant Compliance — Higher reported liabilities may put companies at risk of violating loan covenants or debt agreements.
• Classification Errors — Misclassifying a lease as operating vs. finance can trigger audit scrutiny, restatements, and reputational damage.
• Investor Perception — Finance leases create debt-like optics that may impact valuations, credit ratings, or negotiations.
• End-of-Term Risk — At lease expiration, companies may face fair-market rent resets, renewal risk, or loss of strategic control over a critical asset.
• Disclosure Requirements — ASC 842 mandates extensive footnote disclosures; incomplete or inaccurate reporting can raise regulatory or audit concerns.

Final Takeaway

For any company considering a sale-leaseback, ASC 842 changes how the transaction is reported, not the underlying economics. The classification, recognition of liabilities, and ongoing expense presentation all influence how investors, auditors, and lenders view the company.

Proper planning, accurate calculations, and clear communication of risks are essential to ensure compliance and present the transaction in the best possible light.