Answering ASC 842 FAQs for Businesses of All Sizes
ASC 842, the Codification of Accounting Standards for Leases, represents a significant shift in lease accounting practices. This new standard, issued by the Financial Accounting Standards Board (FASB), aims to enhance transparency and comparability across financial statements by requiring all lessees to recognize lease obligations and right-of-use (ROU) assets on their balance sheets.
This post is created to answer all ASC 842-related queries, addressing the most frequently asked questions and providing a comprehensive overview for businesses of all sizes
Disclaimer:
This blog post will provide an overview of the top 14 most searchable questions related to ASC 842. However, it is essential to consult the full standard and seek professional guidance for in-depth implementation considerations and specific interpretations relevant to your business
Q1. What is ASC 842?
To put it simply, ASC 842 is a new account leasing standard issued by the FASB, replacing the previous guidance found in FAS 13 and IAS 17. It mandates a single lease recognition model for all leases, regardless of their classification as operating or finance leases under prior standards.
Q2. Does ASC 842 Apply to My Business?
Yes, ASC 842 applies to all entities, including public and private companies, not-for-profit organizations, and government agencies, regardless of size or industry. The standard covers all leases, whether for tangible or intangible assets, except short-term leases (less than 12 months) and certain low-value leases.
Q3. What Are the Key Changes Introduced by ASC 842?
The most significant change under ASC 842 is the requirement for all lessees to recognize lease obligations and ROU assets on their balance sheets. This shift from the previous off-balance sheet treatment for operating leases significantly impacts financial statement presentation and key metrics like leverage ratios.
Q4. How Does ASC 842 Define a Lease?
Referring to ASC 842, a lease is defined as a contract that transfers the right to control an underlying asset for a specified period in exchange for consideration. Two key criteria determine whether an arrangement qualifies as a lease:
- Control of the Underlying Asset: The lessee must have the right to control the use of the underlying asset for a specified period. This control encompasses the ability to obtain substantially all the economic benefits from the asset and direct its use.
- Consideration: The lessee must be obligated to make payments in exchange for the right to use the asset.
Q5. How Does ASC 842 Impact the Financial Statements of Lessees?
ASC 842 significantly alters the financial statements of lessees by requiring them to:
- Recognize lease obligations on the balance sheet, representing the present value of the remaining lease payments.
- Recognize ROU assets on the balance sheet. This represents the lessee’s right to use the leased asset.
- Depreciate the ROU asset over the lease term.
- Accrue interest expense on the lease obligation over the lease term.
Q6. What is a Right-of-use (ROU) Asset Under ASC 842?
The ROU asset represents the lessee’s right to control the use of the leased asset for the lease term. It is measured at the present value of the minimum lease payments, excluding any variable lease payments.
Q7. How Are Lease Liabilities Calculated and Recorded Under ASC 842?
The lease liability will be calculated at the present value of the minimum lease payments, i.e., discounted at the lessee’s incremental borrowing rate. This rate reflects the rate at which the lessee could obtain similar financing without the specific terms and conditions of the lease.
Q8. What Are the Different Transition Methods Available Under ASC 842?
ASC 842 offers two transition methods for lessees:
- Retrospective Approach: This method requires lessees to adjust prior period financial statements to reflect the new lease accounting model.
- Modification Approach: This method allows lessees to recognize the cumulative effect of adopting ASC 842 as a technical adjustment to retain the earnings at the date of adoption.
Q9. When Are the Deadlines for Implementing ASC 842?
The implementation deadlines for ASC 842 vary depending on the entity type:
- Public Business Entities (PBEs): For fiscal years beginning after December 15, 2018.
- Non-PBEs: For fiscal years beginning after December 31, 2019.
Q10. How Does ASC 842 Impact Key Financial Metrics Like EBITDA and Leverage Ratios?
The recognition of lease obligations on the balance sheet under ASC 842 increases reported liabilities, potentially impacting key financial ratios like EBITDA and leverage ratios. This can affect creditworthiness and debt covenant compliance.
Q11. What Are the Ongoing Disclosure Requirements for Leases Under ASC 842?
ASC 842 mandates extensive disclosure requirements for leases, including:
- Lease accounting policy
- Description of the leased assets and lease terms
- ROU asset balances and accumulated depreciation
- Lease obligation balances
- Cash flow related to lease payments
- Weighted average discount rate used
Q12. Where Can Businesses Find Resources and Support for Implementing ASC 842?
The FASB and various accounting firms offer resources and guidance on implementing ASC 842, including detailed guidance documents, implementation tools, and webinars.
Q13. How Will ASC 842 Affect the Comparability of Financial Statements Across Different Industries?
By mandating a single lease recognition model, ASC 842 promotes greater comparability of financial statements across different industries. This allows for a more accurate assessment of an entity’s financial position and lease obligations.
Q14. Are There Any Specific Types of Agreements That Are Always Considered Leases Under ASC 842?
Yes, certain agreements are automatically classified as leases under ASC 842, regardless of the transfer of control criteria. These include:
- Agreements that contain a purchase option at a price significantly lower than the fair value of the asset at the end of the lease term.
- Agreements that transfer ownership of the asset at the end of the lease term.
- Agreements that include a non-cancellable lease term.
Conclusion:
ASC 842 will impact all lessees regardless of size or industry. Understanding the key provisions of this standard, including lease identification, accounting treatment, implementation considerations, and ongoing disclosure requirements, is crucial for accurate financial reporting and informed decision-making. Using the resources available and consulting with accounting professionals, businesses can successfully go through the transition to ASC 842 and ensure compliance with this new standard