ASC 842

ASC 842 governs how lessees and lessors account for leases under US GAAP. Its defining change was requiring lessees to recognize a right-of-use asset and a corresponding lease liability on the balance sheet for substantially all leases with a term exceeding twelve months — eliminating the off-balance-sheet treatment that operating leases previously enjoyed under ASC 840.

Lessees classify each lease as either a finance lease or an operating lease. The classification tests examine whether ownership transfers, whether a purchase option is reasonably certain of exercise, whether the lease term covers a major part of the asset's remaining economic life, whether the present value of payments amounts to substantially all of the asset's fair value, and whether the asset is so specialized it has no alternative use. Finance leases produce front-loaded expense split between amortization and interest; operating leases produce a single straight-line lease cost.

The measurement mechanics create real work. Determining the lease term requires assessing whether renewal and termination options are reasonably certain of exercise. Determining the discount rate means using the rate implicit in the lease when readily determinable, and otherwise the incremental borrowing rate — or, for private companies electing the practical expedient, a risk-free rate. Variable payments, index-based escalators, and embedded leases inside service contracts all demand analysis.

For CPA firms, the recurring pain is maintenance rather than adoption: tracking modifications, remeasurement triggers, impairment of right-of-use assets, and reconciling a lease subledger to the general ledger every period. Disclosure requirements include maturity analyses, weighted-average terms and discount rates, and cash flow supplementals.