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Understanding the Implications of FASB's ASC 842 Lease Accounting Standard

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    The Financial Accounting Standards Board (FASB) implemented ASC 842 to replace ASC 840, marking a significant evolution in lease accounting. This new standard aims to increase transparency and comparability among organizations by requiring lessees to recognize right-of-use (ROU) assets and lease liabilities on the balance sheet for all leases, except short-term leases. The motivation behind the standard is to address the lack of transparency associated with off-balance sheet leases, thereby providing a more accurate depiction of an entity's financial obligations.

Implementation Challenges and Solutions

Data Collection and Management: One of the primary challenges in implementing involves gathering and managing detailed lease information. This process requires a comprehensive review of all lease contracts to identify, extract, and analyze relevant data points necessary for compliance. Solution: To manage this, companies have turned to specialized lease accounting software that can store, manage, and analyze lease data, automating many of the calculations required.

System Upgrades: Transitioning to ASC 842 often necessitates upgrading or implementing new IT systems to handle the increased complexity in lease accounting and reporting. Solution: Organizations should evaluate their current systems against the standard's requirements and consider investing in technology solutions that offer the necessary functionality, such as integrated financial reporting and lease management tools.

Training and Policy Changes: Ensuring that staff are well-versed in the new standard and updating internal policies to comply with the standard present additional hurdles. Solution: Comprehensive training programs and clear communication of policy updates are essential. Engaging with external consultants or leveraging educational resources from accounting bodies can also facilitate a smoother transition.

Comparative Analysis with IFRS 16

While ASC 842 and IFRS 16 share the objective of bringing lease obligations onto the balance sheet, there are critical differences in their approaches. For example, IFRS 16 does not provide a distinction between operating and finance leases for lessees, simplifying the accounting process but requiring all leases to be accounted for like finance leases under the Topic 842. This unified approach under IFRS 16 contrasts with the dual model of the 842 standard, which maintains separate accounting treatments for finance and operating leases.

Why the GASB 87?

It is important to note that if your firm is a governmental entity or falls under the jurisdiction of the Governmental Accounting Standards Board (GASB) you will need to comply with GASB 87. The GASB 87 is the lease accounting standard specifically designed for state and local governments, whereas ASC 842 is issued by the Financial Accounting Standards Board (FASB) and applies to all entities, including public, private, and not-for-profit organizations, except for governmental entities. Essentially, the jurisdiction and regulatory environment that the entity operates within will determine which accounting standard it should follow for lease accounting.

Shifting from the ASC 840

The evolution from ASC 840 to ASC 842 by the FASB reflects a transformative approach to lease accounting. This move addresses the shortcomings of the former lease accounting standard, particularly its lack of transparency regarding off-balance sheet lease obligations.

Under ASC 840, leases were classified either as capital or operating, with only capital leases being recognized on the balance sheet. Topic 842, however, introduces a comprehensive model where both types of leases—now termed finance and operating leases—are recorded on the balance sheet. This change shines a light on formerly obscured financial obligations, thereby enhancing the transparency of corporate financial statements. It's a move designed to provide a more accurate portrayal of a company’s leasing activities and their financial impact.

Key Differences
  • Scope and Recognition: Topic 842 broadens the scope of leases included on the balance sheet. All leases, with limited exceptions, now require recognition of right-of-use assets and lease liabilities.
  • Classification and Expense Recognition: While both standards classify leases, the 842 has modified the criteria slightly, altering the way expenses are recognized on the income statement.
  • Disclosure Requirements: There's a pronounced increase in the level of detail required in the disclosures under ASC 842. Companies must now provide extensive qualitative and quantitative details regarding their leasing arrangements.
  • Balance Sheet Impact: Topic 842 mandates that right-of-use assets and lease liabilities for both finance and operating leases be recognized on the balance sheet. This contrasts with ASC 840's requirements, which only capital leases affected the balance sheet.
  • Overall Impact on Business Functions: Transitioning is complex process that extends beyond accounting to include IT system upgrades and possibly changes in real estate management practices. It demands a reevaluation of lease contracts, updates to policies, and potentially new systems for managing compliance.

By recognizing both lease types on the balance sheet, the standard has introduced a level of transparency that reveals much more about a company's financial standing and commitments than was previously required. The presence of these liabilities and assets in the financial statements offers stakeholders a complete view of the company's lease obligations and enhances the comparability of financial statements across entities.

Key Lease Calculations

  • Lease Liability: Present value of future lease payments, discounted using either the rate implicit in the lease or the lessee’s incremental borrowing rate, including fixed and certain variable payments.
  • Right-of-User (ROU) Asset: Calculated as the lease liability plus any prepayments, incentives, and direct initial costs, with the discount rate affecting the initial assessment.
  • Amortization: For finance leases, an amortization schedule distinguishes between interest and principal, decreasing interest expense over the lease term. Operating leases use a straight-line expense method.
  • Journal Entries: Record ROU assets and lease liabilities at the start. Finance leases additionally record interest and amortization of the ROU asset separately, whereas operating leases record a single lease expense.

In contrast to ASC 840, which differentiated between capital and operating leases, the 842's approach provides a uniform framework that requires nearly all leases to be recognized on the balance sheet, enhancing financial transparency and comparability.

Lease Classification Methods

Treatment For The Lessee

Under Topic 842, leases for lessees fall into two categories: finance and operating leases. This classification dictates the accounting treatment and financial statement presentation.

Finance Leases:
  • The right-of-use asset is an entry in the statement of financial position, and so is the liability lease. Unlike the operating lease, amortization, and interest expense are entered as separate entries in the income statement.
  • Variable lease payments are categorized under operating activities, while principal repayments are an entry under financing activities in the cash flows statement. The interest of lease liability's classification is made according to accounting standards ASC 230.
Operating Leases:
  • For the lessee, lease expenses are an income statement entry under operating expenses, and they are recorded on a straight-line method for the lease duration. The figure to use is the sum of the interest expense and the right-to-use asset's amortization. While the former is calculated using the effective interest rate basis, the latter is determined as the difference between the lease's straight-line expense and the lease liability's interest expense.
  • The accounting standards also require that entries of a right-to-use asset be made on the balance sheet together with those of the lease liability. Impairment is tested on this asset as per the accounting standards ASC 360. In addition, operating lease payments are an entry in the statement of cash flows. They fall under the report's operating activities.

Both lease classification types require the lessee to provide enhanced disclosures to provide more insight into their leasing activities. By requiring these recognitions and disclosures, ASC 842 ensures that lessees provide a complete picture of their financial obligations related to leases, promoting greater transparency, and allowing users of financial statements to make more informed decisions.

Treatment For The Lessor

Under 842, leases for lessees fall into two categories: finance and operating leases. This classification dictates the accounting treatment and financial statement presentation.

Operating Leases:
  • Here, the lease will be an entry on the balance sheet. It will be subject to depreciation amortized over the underlying asset's useful life, whereby it might be longer than the lease duration. In addition, depreciation and revenue attributable to the lease are accounted for in the gross amounts in the company's income statement.
  • Another vital guideline is that all cash receipts attributable to the leases are entered as a cash flow statement component under operating activities.
Sales Type Lease:
  • Under the sales-type category, the new standard requires that the lessor establish lease interest income and receivables. It de-recognizes the asset and instead considers the lease's net investment as the entry into the entity's balance sheet, also known as the statement of financial position. To get the net investment, compute the present value of all the future lease receivables plus its unguaranteed residual quantum.
  • The interest income is added while the collected payments are deducted from the lease's net investment. Further, the 842 guides that the selling loss or profit be recorded at the commencement of the lease as an entry in the income statement. The effective rate of interest formula helps calculate the interest income.
  • As with the operating lease, all cash receipts attributable to the lease are an entry in the cash flows statement under operating activities.
Direct Financing Lease:
  • Like above, this type of lease de-recognizes the asset and instead uses net investment income as the balance sheet entry. The net investment, interest income, collected payments, and cash receipts treatment are also similar to the sales-type lease.
  • Selling loss is recorded at the beginning of the lease while profit is deferred.

Practical ASC 842 Example

To further illustrate the application of ASC 842, consider a company that leases several vehicles for delivery purposes with varying lease terms and payment structures. Each lease would need to be evaluated individually to determine the ROU asset and lease liability, taking into account factors such as the discount rate, lease term, and payment structure. These examples highlight the complexity and judgment required in applying the standard, underscoring the importance of detailed lease analysis and documentation.

ASC 842 mandates that all leases be recorded on the balance sheet, revealing previously obscured lease liabilities and ROU assets. Central to this is the use of a discount rate for calculating the present value of lease payments, marking a departure from ASC 840's approach.

Expanded Financial Disclosure Requirements

The ASC 842 Lease Accounting Standard significantly expands the disclosure requirements for both lessees and lessors. Lessees must provide a qualitative and quantitative explanation of their leasing activities, including information about the nature of their leases, significant judgments made, and the amounts recognized in the financial statements. Additionally, lessees are required to disclose a maturity analysis of lease liabilities, showing future lease payments disaggregated by year and categorized by lease type. These disclosures aim to provide stakeholders with a comprehensive understanding of an entity's leasing obligations and the impact on its financial position.

Transition Options and Practical Expedients

The 842 standard offers entities several transition options and practical expedients to ease the burden of adoption. One key expedient allows entities not to reassess lease classification for existing leases at the time of transition. Entities can also choose to apply the new standard using a modified retrospective approach, which does not require restating comparative periods. Deciding on the appropriate transition methods and practical expedients requires careful consideration of their impact on financial reporting and operational processes.

Impact on Specific Industries

The effects of Topic 842 are particularly pronounced in industries with significant operating lease commitments, such as retail, aviation, and real estate. For instance, in the retail industry, where leases for store locations are prevalent, the new standard significantly affects balance sheet metrics, potentially impacting loan covenants and financial ratios. Similarly, in the aviation industry, companies that lease aircraft will see substantial changes in how these transactions are accounted for and reported. Understanding the industry-specific implications of the standard is crucial for entities to adequately prepare for and navigate the changes.

Industry Best Practices and Compliance Strategies

Adopting best practices and strategies is essential for a successful transition from the ASC 840. These include conducting a thorough lease portfolio review, leveraging technology for lease management and accounting, and establishing cross-functional teams to ensure a holistic approach to compliance. Proactive engagement with stakeholders, including auditors, lenders, and investors, to communicate the impact of the new standard on financial statements is also advisable.

Effective Dates

United States public entities and international companies had an effective date of the 15th of December 2019 to comply with the ASC 842 accounting standards. United States non-public entities had an effective date of the 15th of December 2021 to comply with the standards. For more detailed explanation of the effective dates, check out The New Standard's Effective Dates.

The Importance of Transitioning

The FASB Topic 842 Lease Accounting Standard aims to enhance and seal the loopholes of ASC 840, especially on the off-balance sheet items. Here are the major benefits of the new standard:

  • It will promote transparency on the entity's liabilities arising from the various lease agreements, especially the operating leases.
  • It will help standardize accounting for all leases classified under US GAAP.
  • It will lower the number of off-balance sheet activities. Some of the leases that were regarded as off-balance sheet items, e.g., operating leases, are now considered balance sheet transactions.
  • Enhance disclosure to investors on critical information affecting lease arrangements. For, entities that purchase capital-intensive equipment reflect the high debt on their balance sheets. However, those that lease the same capital-intensive equipment seem to have a healthier balance sheet despite having an equally high lease payment obligation.
  • For a more detailed explanation see: Transitioning To The ASC842


The standard necessitates a significant shift in lease accounting practices, emphasizing the need for increased transparency and comparability across entities. By understanding the challenges associated with implementation, the differences and similarities between the global standards, and incorporating practical examples into compliance efforts, entities can navigate this transition more effectively. Furthermore, expanded disclosure requirements under Topic 842 enhance the quality of information available to stakeholders, facilitating a deeper understanding of an entity's leasing activities and financial obligations.

The transition options and practical expedients offer flexibility and relief during the adoption process, allowing entities to choose the approaches best suited to their circumstances. However, selecting these options requires careful consideration of their implications on financial reporting and operational processes.

The impact extends across various industries, each facing unique challenges and considerations. Entities must assess the specific implications of the new standard on their industry and develop tailored strategies for compliance. This includes understanding the potential effects on financial ratios, loan covenants, and overall financial reporting.

Best practices for a successful transition include thorough lease portfolio reviews, leveraging technology to streamline lease management and accounting processes, and establishing cross-functional teams to ensure comprehensive compliance efforts. Engaging with key stakeholders early and often is critical to managing expectations and communicating the impact of ASC 842 on financial statements.

In conclusion, the transition from ASC 840 represents a critical update in lease accounting standards, designed to provide a more accurate picture of an entity's leasing obligations. Entities that approach the transition thoughtfully, leveraging the right tools, resources, and strategies, can achieve compliance effectively while enhancing their financial transparency and stakeholder confidence. By embracing the changes introduced by ASC 842, organizations can not only comply with the new standard but also gain valuable insights into their lease portfolios, enabling better financial and operational decision-making.

iLeasePro for Your ASC 842 Lease Accounting Day 1 and Day 2

iLeasePro is a robust lease management and accounting software designed to streamline both Day 1 and Day 2 tasks under ASC 842, providing comprehensive support to organizations navigating the complexities of lease accounting.

On Day 1, iLeasePro simplifies the initial identification, classification, and measurement of leases by offering tools that automate the evaluation process, ensuring leases are accurately recognized on the balance sheet from the commencement date. Its capabilities include calculating the present value of lease payments, which aids in establishing lease liabilities and corresponding ROU assets, while also factoring in initial direct costs and determining the appropriate discount rate.

Transitioning to Day 2, iLeasePro continues to deliver value by facilitating the ongoing maintenance of lease accounting. The software provides functionalities for regularly updating lease liability measurements and ROU asset amortization, accommodating lease modifications, and ensuring that financial reporting remains accurate and compliant over the lease term.

Furthermore, iLeasePro's comprehensive disclosure features enable organizations to generate detailed reports effortlessly, ensuring transparency and disclosure reporting compliance. By offering a platform that supports both Day 1 and Day 2 processes with efficiency and precision, iLeasePro empowers organizations to manage their lease portfolios effectively, maintaining compliance with lease accounting standards while minimizing the administrative burden.

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    iLeasePro lease accounting software is a robust solution that makes lease management and reporting a breeze. If you want to navigate the complexities of lease standard compliance with ease and have better data visualization, take a tour of iLeasePro to learn more.

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