ASC 842

Definition

ASC 842 is the Accounting Standards Codification topic that governs lease accounting under U.S. Generally Accepted Accounting Principles (GAAP). It requires organizations to recognize most leases on their balance sheets, which significantly changes how leases are reported compared to previous standards. This shift impacts financial reporting, key financial ratios, and the way companies manage their lease portfolios.

5 Must Know Facts For Your Next Test

1. ASC 842 was introduced to enhance transparency and comparability in financial reporting by requiring leases to be recognized on the balance sheet.
2. Under ASC 842, lessees must classify leases as either operating or finance leases, affecting how they record and report lease expenses.
3. The new standard applies to all entities that enter into leases, impacting not only publicly traded companies but also private companies and not-for-profits.
4. Transitioning to ASC 842 may require significant adjustments in accounting systems and processes, leading to potential challenges in implementation.
5. This standard aligns more closely with IFRS 16, although there are still differences in terms of lessee classification and measurement requirements.

Review Questions

• How does ASC 842 change the way organizations account for leases compared to previous standards?
  • ASC 842 changes lease accounting by requiring most leases to be recorded on the balance sheet as both assets and liabilities. Previously, operating leases were kept off-balance-sheet, which made it difficult for stakeholders to assess an organization's financial position accurately. This shift enhances transparency and allows for better comparison across companies by standardizing lease reporting.
• What are some key differences between ASC 842 and IFRS 16 regarding lease classification?
  • Both ASC 842 and IFRS 16 require lessees to recognize nearly all leases on the balance sheet; however, there are key differences in lease classification. Under ASC 842, leases can be classified as either operating or finance leases, while IFRS 16 primarily treats all leases similarly from a recognition standpoint. The criteria for determining whether a lease is classified as finance or operating under ASC 842 differ from those under IFRS, which can affect how each standard impacts financial statements.
• Evaluate the potential impacts of implementing ASC 842 on a company's financial statements and decision-making processes.
  • Implementing ASC 842 can significantly impact a company's financial statements by increasing reported assets and liabilities due to the capitalization of leases. This change can affect financial ratios like debt-to-equity and return on assets, potentially influencing investor perceptions and borrowing costs. Furthermore, with better visibility into leasing obligations, management may reassess their leasing strategies and decisions, considering factors like cash flow management and long-term asset utilization more carefully.

Related terms

Operating Lease: A lease that does not transfer ownership of the asset at the end of the lease term, allowing lessees to expense lease payments over the lease term without recognizing the asset on their balance sheet.

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

IFRS 16: The International Financial Reporting Standard that addresses lease accounting for lessees and requires nearly all leases to be recorded on the balance sheet, similar to ASC 842.