ASC 842

Definition

ASC 842 is the accounting standard that governs the leasing of assets and liabilities on balance sheets, implemented by the Financial Accounting Standards Board (FASB). This standard requires organizations to recognize lease assets and liabilities for most leases, which fundamentally changes how leases are reported in financial statements. The goal of ASC 842 is to increase transparency and comparability in financial reporting by providing a more accurate depiction of a company's financial obligations.

5 Must Know Facts For Your Next Test

1. Under ASC 842, most leases must be recognized on the balance sheet, with a right-of-use (ROU) asset and a corresponding lease liability recorded.
2. The standard differentiates between operating leases and finance leases, each having different impacts on financial statements.
3. For operating leases, lease expense is recognized on a straight-line basis over the lease term, while finance leases involve amortization of the ROU asset and interest expense on the lease liability.
4. ASC 842 includes specific criteria to determine whether a lease should be classified as a finance or operating lease based on factors such as transfer of ownership and the length of the lease term relative to the asset's useful life.
5. Companies must also disclose additional qualitative and quantitative information about leasing arrangements in their financial statement footnotes under ASC 842.

Review Questions

• How does ASC 842 impact the way companies account for operating leases compared to previous accounting standards?
  • ASC 842 significantly alters how companies account for operating leases by requiring them to be recognized on the balance sheet as both a right-of-use asset and a lease liability. Previously, operating leases were typically disclosed only in footnotes without affecting balance sheet figures. This change enhances transparency and provides stakeholders with a clearer picture of an organization's financial commitments.
• Discuss the key differences in financial reporting for finance leases versus operating leases under ASC 842.
  • Under ASC 842, finance leases are recorded with both an ROU asset and a lease liability, leading to amortization of the asset and interest expense on the liability. In contrast, operating leases still result in an ROU asset and liability but incur lease expense recognized on a straight-line basis. This distinction affects profitability metrics differently, with finance leases potentially increasing depreciation and interest expenses upfront while spreading operating lease expenses evenly over time.
• Evaluate how ASC 842 might affect a company's decision-making regarding leasing versus buying assets.
  • With ASC 842 mandating most leases to appear on the balance sheet, companies may reconsider their leasing strategies compared to outright purchasing assets. The visibility of lease liabilities could lead management to prefer buying assets when long-term usage is anticipated, as this could provide better control over costs without impacting financial ratios negatively. Additionally, companies may reassess their capital structure and debt covenants due to changes in reported liabilities from leased assets.

Related terms

Operating Lease: A lease that allows the lessee to use an asset without taking on the risks and rewards of ownership, typically not recorded on the balance sheet under previous standards.

Finance Lease: A lease that effectively transfers ownership rights of an asset to the lessee, resulting in both an asset and a liability being recorded on the balance sheet.

Lease Liability: The obligation to make lease payments over the term of a lease, recognized as a liability on the balance sheet under ASC 842.