The ASC 842 standard for GAAP lease accounting requires that all leases over 12 months are recorded as assets and liabilities on balance sheets.
By now, accounting teams for both public and private companies know they must perform lease accounting under the guidance of ASC 842. But ask many accountants “why,” and they don’t have a good answer.
The best way to ensure your company is accurately operating under ASC 842 is to fully understand the new standard and how it came to be.
Origins of ASC 842
With the financial crisis of the early 2000s, the U.S. Securities and Exchange Commission (SEC) wanted to increase the transparency of an organization’s financial position for better clarity in lease accounting. So, financial reporting portrays accurate valuations for investors. One more recent development in the area of regulated financial transparency is ASC 842.
The FASB worked for years to develop a model that would present virtually every lease on the balance sheet with right-of-use assets and liabilities. A helpful lease accounting tip for private companies: Gain a thorough understanding of the new ASC 842 guidelines and how it undoubtedly impacts your organization.
Defining Lease Accounting
Lease accounting is defined as a set of standards that require an organization to account for its leased assets and the practices and procedures involved in compliance with the standards.
Leased assets may be real estate, manufacturing equipment or airplanes used by another company or organization under a negotiated contract with the company or organization that owns the assets, to name a few.
Leases are similarly classified as operating leases or finance leases, depending on the terms of the agreements.
Defining ASC 842
Accounting Standard Codification Topic 842, ASC 842 or ASU 2016-02, is the new leasing standard to replace the U.S. Generally Accepted Accounting Principles (GAAP) ASC 840 – a nearly 40-year-old standard.
Created by the Financial Accounting Standards Board (FASB), the purpose of the new lease accounting standard is to require organizations that lease assets to disclose the assets and liabilities of their leases on the balance sheet.
The former lease accounting standard (ASC 840) instead reported operating leases in the footnotes of financial statements.
Understanding ASC 842
ASC 842 replaced ASC 840 after Dec. 15, 2018, for fiscal years and interim periods within those fiscal years for public companies and is going into effect for private companies in early 2023 for fiscal years and interim periods within those fiscal years.
The new leasing standard ASC 842 explicitly addresses an issue found in previous reporting methods regarding these leased assets. It closes what many consider a significant accounting loophole in off-balance sheet operating leases.
Much like its predecessor, ASC 840, ASC 842 still classifies lease management into two groups. The first group includes operating leases and finance (capital) leases. The second group includes leases lasting more than 12 months that must be reported on the balance sheet.
However, the ASC 842 standard also requires more robust qualitative and quantitative disclosures.
When the FASB and the IASB started the lease accounting project years ago, the goal was to create a unified set of rules requiring a balance sheet presentation of lease liabilities. Operating leases were widely considered a source of off-balance sheet financing, so the boards pursued requirements for adding assets and liabilities associated with leasing to the balance sheet. The goal of requiring almost all leases to be presented on the balance sheet was accomplished. However, the boards still needed to converge the specific rules. The FASB retained a two-model approach with operating and financing leases, while the IASB selected one model for all leases.
