Lease Accounting for Private Companies: How to Account for ASC 842 Lease Types

Key Takeaways

• Under ASC 842, private companies must generally recognize most leases with terms longer than 12 months on the balance sheet.
• The two main ASC 842 lease types for lessees are finance leases and operating leases.
• “Capital lease” is legacy ASC 840 terminology. Under ASC 842, the modern term is finance lease.
• Lease classification affects how expense is recognized, even though both finance and operating leases are generally recorded on the balance sheet.
• For private companies, the practical challenge is less about understanding one lease in isolation and more about consistently classifying and tracking an entire lease portfolio.

One of the most significant changes under ASC 842 is what type of leases appear on the balance sheet. Between operating leases, capital leases and finance leases, there are a lot of ducks to keep in a row.

Under ASC 840, operating leases and finance leases (formally capital leases) were not reported on the balance sheet in the same way. Today, under ASC 842, private companies generally bring both operating and finance leases onto the balance sheet, which makes correct classification, clean data, and ongoing reporting more important than ever.

What changed for private companies under ASC 842?

For many organizations, the biggest FASB lease accounting changes were:

• bringing most leases onto the balance sheet
• recognizing a right-of-use asset and lease liability for both operating and finance leases
• maintaining lease classification because accounting treatment still differs by lease type
• expanding the amount of lease data needed for measurement, reassessment, and disclosure

Private companies should also evaluate ASC 842 practical expedients during implementation. These elections can simplify adoption by reducing the need to reassess certain historical conclusions, such as whether expired or existing contracts contain leases, prior lease classification, or initial direct costs. Practical expedients can save time, but they should be evaluated carefully because they may affect comparability, documentation, and transition strategy.

This is why lease accounting for private companies is no longer just about identifying a few capital leases. It is about managing lease data consistently across the full portfolio.

What are the lease types under ASC 842?

The primary types of leases under ASC 842 for lessees are:

• finance leases
• operating leases

We know now that all lease contracts with terms longer than one year will be added to financial statements. Almost every lease will need to have a corresponding Right of Use (ROU) Asset and Lease Liability, regardless of classification type. That means the classification question is no longer “Is this on the balance sheet?” but rather “How should this lease be accounted for after recognition?”

Accounting for finance leases under ASC 842

A finance lease is the ASC 842 term that replaced the older capital lease label. For lessees, a lease is classified as a finance lease when it meets one or more of the relevant ASC 842 criteria; otherwise, it is generally an operating lease.

In practice, finance lease classification often focuses on whether:

• ownership transfers to the lessee by the end of the lease term
• the lessee is reasonably certain to exercise a purchase option
• the lease term covers a major part of the remaining economic life of the asset
• the present value of lease payments equals or exceeds substantially all of the fair value of the asset
• the asset is so specialized that it is expected to have no alternative use to the lessor at the end of the term
  
  

As a result of finance lease classification, lease expense is typically recognized through amortization of the right-of-use asset and interest on the lease liability rather than through a single straight-line lease expense pattern.

Finance lease data private companies need to track

Under ASC 840, finance leases required specific data points for accounting calculations. Data points include:

• Lease possession date
• Lease expiration
• Option dates and an assessment if the option is reasonably certain to be exercised
• Rent payment amounts
• The company’s incremental borrowing rate

However, under ASC 842, those data points are needed for virtually every lease. That is one reason lease accounting for private companies can become difficult to manage in spreadsheets alone.

ASC 842 capital lease: what changed?

As we know by now, in 2016 the Financial Accounting Standards Board (FASB) amended its accounting rules. They chose to change the term capital lease to finance lease. The terminology change was part of the broader leasing update in Topic 842. FASB’s leasing standard requires lessees to recognize lease assets and lease liabilities for most leases with terms longer than 12 months and distinguishes between finance and operating leases for subsequent accounting.

Many American lease accountants still colloquially use the term “capital lease” but finance lease is the correct term in ASC 842 reporting. That makes ASC 842 capital lease an important keyword from a search perspective, but in the body copy it is best handled as a clarification:

• “capital lease” = legacy ASC 840 terminology
• “finance lease” = current ASC 842 terminology

This distinction matters because many users still search for capital lease language even when they are really looking for finance lease accounting under ASC 842.

Accounting for operating leases under ASC 842

An operating lease is a lease that does not meet the finance lease criteria. Even so, operating leases generally still appear on the balance sheet under ASC 842 for lessees when the lease term exceeds 12 months. The main difference is the expense pattern after recognition.

Historically, the overwhelming majority of leases have been operating leases. For a long time, those leases remained buried in the footnotes rather than appearing on the balance sheet. ASC 842 will change that for private-company reporting by requiring operating leases to be recognized on the balance sheet as well.

For many private companies, the operational impact is significant because operating leases often make up the largest share of the portfolio.

Finance lease vs. operating lease: which is which?

The differences appear in the criteria. Ownership, purchase options, estimated useful life of the asset, lease term and lessee usage all combine to determine whether you have an operating lease or a finance lease.

A simple way to think about the distinction is:

• finance leases generally resemble financed purchases more closely
  
  
• operating leases generally produce a single lease expense pattern over the lease term
  
  
• both generally create a right-of-use asset and lease liability under ASC 842 for private companies when the lease term is longer than 12 months
  
  

That is why the question is not whether private companies need to account for these leases. The real question is how each lease should be classified and how that classification affects reporting.

How to manage multiple ASC 842 lease types

Don’t try to take it on alone.

An intelligent, advanced lease accounting solution can be the best coworker you’ve ever had. The right platform should help your team:

• centralize lease data
• classify leases consistently
• calculate lease liabilities and right-of-use assets
• generate journal entries
• support ongoing reassessments and reporting
• integrate with existing accounting systems
• help manage both lease accounting and lease administration workflows

Choosing a comprehensive, proven lease accounting, lease management and lease administration software allows you to manage leases in the manner that best suits your company and meets ASC 842 guidelines.