Asc 842

Definition

ASC 842 is the accounting standard that governs the recognition, measurement, and presentation of lease transactions in financial statements. This standard requires companies to recognize lease assets and liabilities on their balance sheets, effectively changing how leases are reported compared to the previous standard, ASC 840. With ASC 842, lessees must record a 'right-of-use' asset and a corresponding lease liability for most leases, significantly impacting financial ratios and statements.

5 Must Know Facts For Your Next Test

1. ASC 842 became effective for public companies in 2019 and for private companies in 2020, requiring compliance with the new reporting requirements.
2. Under ASC 842, lessees must assess whether a contract is a lease at inception and classify it as either an operating or finance lease.
3. The standard aims to enhance transparency in financial reporting by providing more comprehensive information about leasing activities.
4. Lessees are required to disclose additional qualitative and quantitative information about their leasing arrangements in their financial statements.
5. Non-compliance with ASC 842 can lead to significant restatements of financial statements, affecting investors' perceptions and potential regulatory scrutiny.

Review Questions

• How does ASC 842 change the way companies account for leases compared to the previous standard?
  • ASC 842 changes lease accounting by requiring companies to recognize lease assets and liabilities on their balance sheets, whereas under the previous standard, ASC 840, many leases were kept off-balance-sheet. This shift means that most leases are treated as finance leases or operating leases, with lessees recording a right-of-use asset and a corresponding lease liability. The result is a more accurate reflection of a company's financial obligations and resources related to leasing.
• What are the key criteria that determine whether a lease is classified as an operating lease or a finance lease under ASC 842?
  • Under ASC 842, a lease is classified as a finance lease if it meets any one of five criteria: transfer of ownership at the end of the term, an option to purchase the asset that is likely to be exercised, the lease term covers a major part of the asset's useful life, the present value of lease payments equals or exceeds substantially all of the fair value of the asset, or it is of such specialized nature that it has no alternative use. Any leases that do not meet these criteria are classified as operating leases.
• Evaluate how the implementation of ASC 842 impacts financial ratios and company valuation in practice.
  • The implementation of ASC 842 can significantly impact key financial ratios such as debt-to-equity and return on assets. By adding right-of-use assets and lease liabilities to the balance sheet, companies may appear more leveraged than before, affecting their perceived risk profile and borrowing capacity. Investors may need to adjust their valuation models to account for these changes in financial reporting. Consequently, understanding these impacts is critical for both management and investors as they evaluate company performance and stability in a post-ASC 842 environment.

Related terms

Right-of-Use Asset: An asset that represents a lessee's right to use an underlying asset for the lease term, recognized on the balance sheet under ASC 842.

Lease Liability: A liability representing the present value of future lease payments that a lessee is obligated to make over the lease term.

Operating Lease: A lease that does not transfer ownership of the underlying asset and is typically shorter than the asset's useful life, now requiring recognition of both the right-of-use asset and lease liability under ASC 842.