Asc 842

Definition

ASC 842 is the accounting standard that governs the recognition, measurement, presentation, and disclosure of leases. This standard significantly changes how leases are reported on financial statements, requiring organizations to recognize lease assets and liabilities on their balance sheets, thereby increasing transparency and providing a clearer picture of a company's financial obligations.

5 Must Know Facts For Your Next Test

1. Under ASC 842, all leases with terms greater than 12 months must be recorded on the balance sheet, significantly increasing reported assets and liabilities for lessees.
2. The standard introduces a dual model for lessees, distinguishing between operating leases and finance leases based on criteria such as transfer of ownership and economic life.
3. Lessee accounting under ASC 842 requires the recognition of a right-of-use asset representing the lessee's right to use the leased property during the lease term.
4. Lessors continue to classify leases as either operating or finance leases, but they also have additional disclosure requirements under ASC 842.
5. The effective date for public entities to adopt ASC 842 was for fiscal years beginning after December 15, 2018, while private companies had until December 15, 2019.

Review Questions

• How does ASC 842 change the way organizations account for leases compared to previous standards?
  • ASC 842 requires that most leases be recorded on the balance sheet as both a right-of-use asset and a lease liability, which was not a requirement under previous standards like ASC 840. This change increases transparency regarding a company's financial obligations and overall financial health. It also alters how organizations manage their lease portfolios and impacts key financial metrics such as debt ratios and return on assets.
• What are the main differences between operating leases and finance leases under ASC 842, and how do they affect financial statements?
  • Under ASC 842, an operating lease is recorded as an expense on the income statement without recognizing an asset or liability on the balance sheet, while a finance lease requires both an asset and liability to be recorded. The classification affects how expenses are reported; finance leases typically result in higher initial expenses due to depreciation and interest, whereas operating leases have straight-line rent expenses. This classification affects key financial ratios such as leverage and return metrics.
• Evaluate the implications of ASC 842 on financial reporting and decision-making for organizations that engage in leasing activities.
  • The adoption of ASC 842 has major implications for financial reporting as it increases both transparency and accountability concerning leasing transactions. Organizations must reassess their leasing strategies since higher balance sheet liabilities may affect their borrowing capacity and financial ratios. The change also impacts stakeholders' perceptions as investors may see companies with significant lease obligations differently. Furthermore, companies may reconsider their leasing arrangements versus outright purchases due to the accounting treatment influencing cash flow management and capital allocation decisions.

Related terms

Operating Lease: A lease that does not transfer ownership of the asset and is treated as an expense on the income statement rather than being capitalized on the balance sheet.

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

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