ASC 842

Leases are a routine part of doing business—covering everything from office space to equipment—but under the old accounting rules, many never made it onto the balance sheet. ASC 842 changes that. Introduced by the FASB, this standard brings more visibility and consistency to lease accounting by requiring most leases to be recorded as assets and liabilities. Let’s break down what ASC 842 is, why it matters, and what businesses need to know to stay compliant.

What Is ASC 842?

ASC 842 is the Financial Accounting Standards Board’s (FASB) latest lease accounting standard, introduced to improve transparency and consistency in financial reporting. This update replaces ASC 840 and significantly changes how companies recognize leases on their financial statements. While ASC 840 allowed many operating leases to remain off the balance sheet, ASC 842 requires almost all leases to be recorded as both assets and liabilities.

The core idea behind ASC 842 is simple: if a company is contractually committed to paying for the use of an asset, that obligation should appear on its balance sheet. The new standard requires organizations to recognize a “right-of-use” (ROU) asset and a corresponding lease liability for leases longer than 12 months.

This affects both lessees and lessors. Lessees must categorize leases as either finance or operating, both of which now appear on the balance sheet. Lessors, meanwhile, continue to classify leases as operating, sales-type, or direct financing, but with updated criteria.

Key Objectives of ASC 842 for Improved Transparency

The FASB had three main objectives with the ASC 842 standard:

• Enhance financial transparency: ASC 842 forces companies to show the full extent of their lease obligations. This makes it easier for investors, lenders, and regulators to assess the true financial health of an organization.
• Close off-balance-sheet loopholes: Under ASC 840, companies could avoid the recognition of  large obligations by structuring them as operating leases. ASC 842 addresses this by bringing most leases onto the balance sheet.
• Improve comparability: By aligning lease reporting across industries and organizations, ASC 842 makes financial statements more consistent. This comparability allows for better benchmarking and investment analysis.

In practice, this means a company with $10 million of lease commitments will now report those obligations, giving stakeholders a fuller picture of long-term liabilities.

As a result, companies in real estate-heavy industries like retail, logistics, and airlines have seen a significant shift in their reported balance sheets. For example, Walgreens reported nearly $34 billion in lease obligations after adopting ASC 842, a staggering number that was largely off the books under ASC 840.

Key ASC 842 Compliance Requirements

Meeting ASC 842 requirements involves more than just updating a few spreadsheets. Companies must reassess their lease portfolio and accounting systems from top to bottom. Here are the core compliance steps:

• Identify all leases: Any agreement that conveys the right to control the use of an asset must be evaluated under ASC 842. This includes contracts traditionally not labeled as leases.
• Classify the lease: Lessees must determine whether each lease is a finance lease or an operating lease. Classification affects how expenses are recorded.
• Measure lease liability and ROU asset: Lease liabilities are measured at the present value of future lease payments, using a discount rate. The ROU asset includes the liability amount, initial direct costs, and any prepayments or incentives.
• Recognize and report: Both the lease liability and ROU asset must appear on the balance sheet. Lease expenses are recorded based on classification: straight-line for operating leases and front-loaded for finance leases.
• Disclose adequately: Detailed disclosures are required, including lease terms, discount rates, maturity schedules, and qualitative information about lease-related risks and assumptions.
• Monitor and update: Leases must be continually reassessed for modifications or changes, triggering potential ASC 842 adjustment entries.

ASC 842 vs. ASC 840: What Changed?

The transition to lease accounting ASC 842 represents one of the most significant changes in lease reporting in decades. Here are the key differences from ASC 840:

• Balance sheet recognition:
  • ASC 840: Operating leases stayed off the balance sheet.
  • ASC 842: Nearly all leases go on the balance sheet.
• Lease classification:
  • ASC 840: Capital vs. operating leases, with only capital leases recorded on balance sheet.
  • ASC 842: Finance vs. operating leases, but both recorded on balance sheet.
• Lease term evaluation:
  • ASC 840: Lease classification is determined at the lease inception date, which is when the agreement is finalized and the parties are committed to the lease terms.
  • ASC 842: Lease classification is assessed at the lease commencement date, defined as the date the lessor makes the underlying asset available for use by the lessee.
• Disclosures:
  • ASC 840: Minimal disclosure requirements.
  • ASC 842: Enhanced disclosure requirements to improve transparency.
• Sale-leaseback and leveraged leases:
  • ASC 842 redefines sale-leaseback rules, requiring alignment with ASC 606 for revenue recognition. It also eliminates the special accounting for leveraged leases, simplifying compliance and closing loopholes.
• Lease reassessment:
  • ASC 842 includes more comprehensive guidance on how to handle lease modifications, including detailed rules for whether changes require remeasurement or a new lease.

Final Thoughts

ASC 842 is more than just an accounting update—it represents a strategic move toward enhanced financial transparency and accountability. With the added complexity of lease structures and the administrative demands of compliance, many organizations are turning to specialized software to streamline ASC 842 accounting and align with ASC 842 revenue recognition requirements.

Ultimately, ASC 842 brings lease obligations into the spotlight by placing them clearly on the balance sheet. For companies ready to embrace the change, the payoff is greater financial clarity, increased stakeholder confidence, and the assurance that their reporting reflects the true scope of their commitments.