ASC 842

Definition

ASC 842 is the accounting standard that governs lease accounting, replacing the previous standard ASC 840. It establishes a comprehensive framework for how lessees and lessors account for leases in their financial statements, emphasizing the need for greater transparency regarding lease obligations and assets. This standard significantly impacts lease classification, accounting for both lessees and lessors, as well as handling sale and leaseback transactions, modifications, subleases, and disclosures.

5 Must Know Facts For Your Next Test

1. Under ASC 842, all leases longer than 12 months must be recognized on the balance sheet, leading to increased visibility of leasing obligations.
2. Lessees are required to classify leases as either finance leases or operating leases, affecting how they recognize expenses and assets in their financial statements.
3. Lessors account for leases differently based on whether they are classified as sales-type leases, direct financing leases, or operating leases.
4. Sale and leaseback transactions under ASC 842 involve transferring an asset's ownership while allowing the seller to continue using it, impacting how both parties recognize gains or losses.
5. ASC 842 requires detailed disclosures regarding leasing arrangements in financial statements, including maturity analysis and qualitative information about leasing activities.

Review Questions

• How does ASC 842 change the way lessees classify leases compared to the previous standard?
  • ASC 842 introduces a more transparent approach by requiring lessees to classify leases as either finance or operating leases based on whether they transfer substantial risks and rewards of ownership. This is different from ASC 840, where only operating leases were off-balance-sheet. Under ASC 842, both types of leases must be recognized on the balance sheet, which provides clearer insights into a company's financial obligations.
• Discuss the differences in accounting treatment between lessors under ASC 842 when dealing with sales-type leases versus operating leases.
  • Under ASC 842, lessors treat sales-type leases by recognizing a sale transaction where the asset's carrying amount is derecognized and revenue is recognized at lease commencement. Conversely, for operating leases, lessors maintain ownership of the asset on their balance sheets and recognize lease income over the term of the lease. This differentiation impacts how lessors report revenue and asset utilization in their financial statements.
• Evaluate how ASC 842 affects financial statement users' analysis of a company's financial health compared to previous standards.
  • ASC 842 enhances transparency for financial statement users by bringing operating leases onto the balance sheet, which affects key financial metrics like leverage ratios and EBITDA. This shift allows investors and creditors to better assess a company's financial health by gaining insight into its leasing obligations. The increased disclosure requirements also enable stakeholders to understand the nature and extent of leasing arrangements more comprehensively, influencing investment decisions and risk assessments.

Related terms

Operating Lease: A lease that does not transfer ownership of the asset to the lessee at the end of the lease term and is typically expensed on a straight-line basis.

Finance Lease: A lease that transfers substantially all the risks and rewards of ownership to the lessee, requiring lessees to recognize the asset and liability on their balance sheet.

Lease Liability: An obligation arising from a lease agreement, representing the present value of future lease payments that a lessee is required to make.