ASC 842 Leases
ASC 842 is effective for public companies for the fiscal year ended later than December 15, 2018 and for all other organizations for the fiscal year ended later than December 15, 2021.
ASC 842 will replace ASC 840.
What are the goals of ASC 842?
- By recognizing lease assets and lease liabilities on the Balance Sheet, ASC 842 will increases transparency and comparability among organizations.
- ASC 842 adds operating leases to the Balance Sheet, in addition to finance leases.
- ASC 842 Removes Deferred Rent and Prepaid Expense.
- ASC 842 requires further disclosures in the footnote
What are the major differences between ASC 840 and ASC 842?
- Under ASC 842 operating leases will be reported on the balance sheet, as an asset and liability while under ASC 840 it wasn’t.
- Capital leases under ASC 840 called now Finance leases under ASC 842.
- Under ASC 840 we had four criteria to classify lease as a finance lease, under ASC 842 there are five criteria:
If any one of these five criteria are met, at its inception, the lease should be considered a finance lease:
- Transfer of ownership.
- Lease purchase option.
- Lease term – If the lease term is equal to 75% or more of the estimated economic life of the leased property.
- Present value – If the present value of the sum of the minimum lease payments and any residual value equals or exceeds substantially all of the fair value of the underlying asset (90% or more).
- Alternative use – If the underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
- Instead of deferred or prepaid expenses under ASC 840 we will have ROU and lease liability under ASC 842.
- Initial direct costs of operation lease is part of the ROU.
- Since under ASC 842 the balance sheet changes the cash flow statement change as well.
- ASC 842 require much greater disclosure in the footnotes (for instance, maturity schedule
Similarities between ASC 842 and ASC 840
- Under both ASC 842 and ASC 840 the income statement is the same.
- Under both ASC 842 and ASC 840 the calculation of Capital and finance lease is the same.
- Under both ASC 842 and ASC 840 the renewal criteria is the same, just a small change in the wording. Reasonably assured = reasonably certain
Under ASC 842 there are policy elections that can be made by the company.
Short Term Leases
Lessees may elect NOT to apply the standard to leases of 12 months or less.
Lessee may elect to account for lease and nonlease components as a single combined lease component, Lessee will not have to allocate between lease and nonlease payments. On one hand, it will save time. On the other hand, by treating nonlease components as lease components, the lessee will have a larger Lease Liability and ROU Asset.
If the rate implicit in a lease is not readily available, non-public entities can elect to use the risk free rate in lieu of determining an incremental borrowing rate.
Under ASC 842 there are presentation requirements.
Under ASC 842 lessee shall present the following either in the statement of financial position or footnote:
- Finance Lease ROU Assets and Operating Lease ROU Assets separate from each other and from other assets.
- Finance lease liabilities and operating lease liabilities separate from each other and from other liabilities
Lessee may elect to apply the Lease Standard either to all reporting periods presented or only to the most recent period without restating prior periods.
ASC 842 allow electing the following transition reliefs as a package and applying to all leases:
- Lessee need not reassess whether any expired or existing contracts are or contain leases.
- Lessee need not reassess the lease classification for any existing or expired leases.
- Lessee need not reassess the initial direct costs for any existing leases (whether those costs would have qualified for capitalization under the new lease accounting standard).
- Elect the following as a package and apply to all leases.
- Lessee uses hindsight with respect to lease renewals and purchase options when determining the lease term.
- Lessee uses hindsight in assessing impairment of a ROU asset.
ASC 842 allows a company to apply a single discount to a portfolio of leases with reasonably similar characteristics, however, it might be disadvantageous for a company to elect such a policy.