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. The new standard from the FASB seeks to make financial statement information more transparent and comparable. A lessee has to recognise its lease obligations and right-of-use assets on the balance sheet.
This post is created to answer the most frequently asked questions on ASC 842 to provide readers with a comprehensive overview of all types of businesses.
Disclaimer:
This blog post will answer the top 11 most searched questions related to ASC 842. Nevertheless, consulting the full standard and getting professional assistance is necessary for in-depth implementation consideration and specific interpretation relevant to businesses.
Q1. What is ASC 842?
ASC 842 is a U.S. GAAP lease accounting standard that requires leases over 12 months to be recorded on the balance sheet as assets and liabilities. It classifies as either a finance or operating lease, for better financial reporting.
This standard replaced ASC 840, which didn’t require operating leases to be capitalized. Introducing ASC 842 will enhance financial statements by making it clearer what a company has in terms of obligations, improving transparency for investors and lenders.
Q2. Does ASC 842 Apply to My Business?
ASC 842 lease accounting is important for businesses as it fundamentally alters the accounting treatment of leases, influencing financial reporting, budgeting and decision-making. Companies must evaluate their lease portfolios, review lease agreements and implement the correct accounting practices per ASC 842.
Adhering to ASC 842 is essential for accurate and transparent financial reporting, regulatory compliance and meeting investor and stakeholder expectations. Non-compliance can lead to inaccurate financial statements, legal issues and damage to a company’s reputation.
Q3. What Are the Key Changes Introduced by ASC 842?
The new lease accounting standard, ASC 842, requires lessees to capitalize both operating and finance leases on the balance sheet. It leaves a significant impact on lessees since changes are not significant for lessor and lessees with capital leases (now referred to as finance leases) accounting treatment remains almost unchanged.
Q4. How Does ASC 842 Define a Lease?
The FASB’s ASC 842, Leases, brings transparency as all leases have to be recorded on a company’s balance sheet. Operating leases must recognise a right-of-use (ROU) asset and lease liability at lease commencement.
The operating and finance leases are now brought on the balance sheet and income statement, with separate disclosures for assets and liabilities.
According to ASC 842, a lease is defined as a contract that provides the right to control the use of an identified asset for a specified period in exchange for consideration.
Q5. How Does ASC 842 Impact the Financial Statements of Lessees?
ASC 842 adds a right-of-use (ROU) asset and lease liability to a balance sheet, increasing both assets and liabilities. It affects various debt-based financial metrics such as return on assets (ROA).
On the income statement, operating lease accounting are merely reported as lease expenses, but finance leases split the costs between interest and amortization.
Q6. What is a Right-of-use (ROU) Asset Under ASC 842?
The right-of-use (ROU) asset represents the lessee’s right to control the use of the underlying lease asset for a specified period.
Q7. How Are Lease Liabilities Calculated and Recorded Under ASC 842?
Under ASC 842, lease liabilities are calculated by finding the present value of future lease payments, discounted by the rate implicit in the lease or the company’s borrowing rate. Payments include fixed payments, residual value guarantees, purchase options and termination payments. The lease liability must be recorded together with the right-of-use asset when the lease begins.
Q8. What Are the Different Transition Methods Available Under ASC 842?
Under ASC 842, lessees can choose between two methods. The first one is comparative, which applies the standard retroactively but requires more effort. The effective Date Method only applies from the transition date but may cause differences with prior financial statements.
Q9. How Does ASC 842 Impact Key Financial Metrics EBITDA?
Under ASC 842, the impact on EBITDA depends on the lease classification. For finance leases, interest and amortization expenses are separated, which increases EBITDA by excluding these non-operating costs. On the other hand, for an operating lease, lease expenses would fall under the cost of operation, and hence EBITDA remains the same.
The new lease rules for operating leases on balance sheet reporting impact a few key financial ratios, including the current ratio and debt to EBITDA. This requires companies to reconsider how they manage these metrics under the new standard.
Q10. What Are the Ongoing Disclosure Requirements for Leases Under ASC 842?
Under ASC 842, lessees must provide both qualitative and quantitative disclosures about their leases. These include:
- The Details of Leases: Information regarding the nature, terms and conditions of leases.
- Significant Judgments: Key decisions made when applying lease accounting rules, such as determining lease terms or discount rates.
- Amounts in Financial Statements: Quantitative data showing the lease-related amounts recognized, such as lease liabilities, right-of-use (ROU) assets and lease expenses.
Q11. 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.
Conclusion:
ASC 842 will impact all lessees regardless of size or industry. Understanding 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.