Understanding ASC 842
You’ve probably heard rumblings about the FASB’s new reporting standard for leases – Accounting Standards Update No. 2016-02, Leases (Topic 842). This new standard will become effective for non-public business entities for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. This standard requires companies to include more leases than ever on their balance sheet.
For many, this challenge is significant. Historic leases may not be stored in a central location or include clear language. Additionally, embedded leases exist within all sorts of other contracts.
For many of our clients, implementation may require significant investment(s), attention, and leadership time. New or upgraded systems may be necessary. Most importantly, reviewing and understanding existing lease agreements will be required to capture specific information at new levels of detail. In other words, this may be a bigger undertaking than many anticipated.
Accounting under ASC 842
Many companies lease assets – such as buildings, equipment, and vehicles. A lease is a contract, or part of a contract, that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Control over the use of the identified asset means that the customer has both (1) the right to obtain substantially all of the economic benefits from the use of the asset, and (2) the right to direct the use of the asset. In most cases, consideration reflects lease payments over the course of the lease.
Under ASC 842, all operating leases must be presented on the balance sheet by recording a debit to the right-of-use (ROU) asset, with a corresponding credit for the lease liability.
Why does this matter?
The purpose of ASC 842 is to bring most operating leases, which are currently accounted for off-balance sheet, onto the balance sheet. This will provide financial statement users a more realistic view of the lease obligations of an individual company. This may be particularly important for those looking to buy, sell, or invest in an organization.