Are you beginning to plan for your transition to ASC 842? Learn about the biggest ASC 842 balance sheet changes, the important implications of the changes, and get access to a helpful resource that explains the details and the transition process.
WHAT’S NEW in ASC 842: balance sheet changes
Here’s an overview of what has changed under the new standard, and how the ASC 842 balance sheet changes will impact your financial reporting.
Most leases are now included on the balance sheet.
Prior to ASC 842, only capital leases (leases that are essentially purchase agreements) were recorded on the balance sheet.
Under the new standard, companies must report right-of-use (ROU) assets and liabilities for almost all leases (including operating leases), with the exception of short term leases with terms of 12 months or less. That means not only high-value real estate leases, but also leases for IT and office equipment, vehicles, construction equipment, and other leased assets.
This is the biggest change in ASC 842, and it’s why the transition will be a major project for most companies. You will need to find, extract, and centralize all your lease data so you can add assets and liabilities to the balance sheet.
Leases have a much larger impact.
For any firm with more than a few leases, the total of all leases that must be reported under ASC 842 represents a significant value that was not previously visible on your balance sheet. When you add that value to your total assets and liabilities, the overall picture will look very different than it did in the past.
That’s one reason it’s important to start your transition well in advance. Your financial leadership will want to understand the impact the ASC 842 balance sheet changes have on your company’s financial statements and make decisions accordingly.
Embedded leases must be reported.
To complicate things further, it’s not only property and equipment lease contracts that you’ll need to include on the balance sheet. You will also need to report on embedded leases, which are components within contracts that entail the use of a particular asset, where the user has control over that asset.
A lease may exist within a contract even though the contract may not contain the word “lease.”
For example, many service contracts include assets that are supplied by the vendor as part of the service.
Examining your contracts and identifying embedded leases can be a complex and time consuming task, so this new requirement is another good reason to get started on your transition sooner rather than later.
Revised lease type terminology.
FASB has adjusted the terminology for leases that represent a purchase agreement, formerly known as capital leases. In the ASC 842 standard, these leases are now called finance leases. The treatment of finance leases under 842 is essentially the same as treatment for capital leases under the previous standard.
Revised lease classification test.
A fifth lease classification question has been added in ASC 842, as part of the test to determine whether a lease is a finance lease or an operating lease:
Alternative use test: Is the asset so specialized that it is only useful to the lessee?
This new test question means that after the asset is returned to the lessor, will it have no value to anyone else without a major overhaul by the lessor?
As in the previous standard, if you answer YES to one or more of the lease classification questions, the lease must be classified as a finance lease.
In addition, the “bright lines” for lease classification tests have been removed in ASC 842. Previously, a “major part” of economic life was defined as 75%, and “substantially all” of the fair market value was defined as 90%. In ASC 842, these percentages are now considered guidelines under the new standard and you can elect what percentage you choose to use.
New treatment of operating leases on the balance sheet.
In the past, operating leases were unrecorded liabilities, with the balance sheet only including prepaid or deferred rent. Adding operating leases is the biggest of the ASC 842 balance sheet changes.
Under the new FASB standard, operating leases are capitalized on the balance sheet in a similar way we previously would record capital leases under ASC 840: by recording an asset and a liability. Liability is accounted for using an amortized cost basis. Amortization of the ROU asset is calculated as the difference between straight line rent and interest expense for the period.
These two expenses added together give you the total lease expense to book on your P&L.
New requirements for disclosure reports.
Under ASC 842, disclosure reports must include more qualitative and quantitative details, including:
- weighted average discount rate
- weighted average remaining lease term
- cash paid for amounts included in lease liabilities
- a more descriptive maturity analysis (which must be tied back to the balance sheet)