The ASC 840 and ASC 842 accounting standards have been making waves in the business world. These standards are set by the Financial Accounting Standards Board (FASB) and relate to how companies account for their leases. If you’re running a business or just want to understand these standards, this article will provide you with a comprehensive overview of ASC 840 vs 842.
What Is ASC 840?
ASC 840 is the previous standard for accounting for leases in the US. Under this standard, operating leases were not recorded on the balance sheet, which means that companies did not have to report their lease liabilities. This standard has been in place for many years and has allowed companies to keep their lease liabilities off the books.
What’s Changing With ASC 842?
ASC 842 is the new lease accounting standard that replaced ASC 840 in 2019. The main change with ASC 842 is that companies are now required to recognize their lease liabilities on the balance sheet. This means that all leases, including operating leases, must now be reported on the balance sheet. The new standard also introduces new disclosure requirements for companies.
The main reason for the change:
The main reason for the change in the accounting standard was to provide a more accurate representation of a company's financial position. Under ASC 840, companies could structure their leases in a way that allowed them to keep their lease liabilities off the balance sheet, making their financial position appear stronger than it actually was. This approach made it difficult for investors and other stakeholders to assess a company's true financial position.
Under ASC 842, companies must recognize a lease liability and a right-of-use asset on their balance sheet for most leases. The right-of-use asset represents the company's right to use the leased asset for the lease term, while the lease liability represents the obligation to make lease payments over the lease term.
The new standard also introduces new disclosure requirements for companies.
Companies are now required to provide more detailed information about their leases in their financial statements, including the lease term, the discount rate used to calculate the lease liability, and a maturity analysis of lease liabilities. This additional information allows investors and other stakeholders to better understand a company's lease obligations and their impact on its financial position.
The adoption of ASC 842 has significant implications for companies, as it requires changes to accounting systems, processes, and controls. It also requires companies to carefully assess their leases and determine which ones meet the definition of a lease under the new standard. Companies should also consider the impact of the new standard on their financial statements and key financial ratios, and communicate these changes to their stakeholders
ASC 840 to ASC 842 transition date
The transition date for ASC 842 was January 1, 2019, for public companies and January 1, 2022, for private companies. This means that companies were required to adopt the new standard from these dates.
What Do the ASC Transition Mean for Companies?
The transition from ASC 840 to ASC 842 has significant implications for companies. Here are some of the key things that companies need to be aware of:
- Increased Transparency: With the adoption of ASC 842, companies are now required to report their lease liabilities on their balance sheets, which provides a more accurate representation of their financial position. This increased transparency can help investors and other stakeholders to better understand a company's financial position and its lease obligations.
- Impact on Financial Ratios: The adoption of ASC 842 may have an impact on a company's financial ratios, such as debt-to-equity ratios and interest coverage ratios. This is because the recognition of lease liabilities on the balance sheet will increase a company's reported debt. Companies should be aware of the potential impact on their financial ratios and communicate any changes to their stakeholders.
- Changes to Lease Administration: The new standard requires changes to lease administration, as companies will need to gather more information about their leases, such as lease term, renewal options, and discount rates. Companies will also need to reassess their lease classification, which could result in changes to their lease accounting.
- Changes to Financial Systems: The adoption of ASC 842 requires changes to financial systems, as companies will need to track lease payments and amortization of lease assets and liabilities. This may require changes to accounting systems, processes, and controls.
- Transition Methods: Companies have a choice of transition methods for adopting ASC 842. The most common methods are the modified retrospective approach and the full retrospective approach. Companies should carefully evaluate the pros and cons of each method and choose the method that best suits their needs.
- Disclosure Requirements: The new standard introduces new disclosure requirements, including the lease term, discount rate, and maturity analysis of lease liabilities. Companies should ensure that they have adequate processes in place to gather and report this information in their financial statements.
Overall, the adoption of ASC 842 requires significant changes to accounting systems, processes, and controls. Companies should carefully evaluate the impact of the new standard on their financial statements, financial ratios, and lease administration. They should also communicate any changes to their stakeholders to ensure transparency and compliance with the new standard.
What Are the Key Differences Between ASC 840 and ASC 842?
The key differences between ASC 840 and ASC 842 are as follows:
Here are some of the key differences between ASC 840 and ASC 842:
- Recognition of Operating Lease Liabilities: Under ASC 840, operating lease liabilities were generally not recognized on the balance sheet. However, under ASC 842, companies are required to recognize operating lease liabilities on the balance sheet. This means that companies will need to record the present value of lease payments as a liability, and a corresponding right-of-use asset.
- Definition of a Lease: ASC 842 provides a more detailed definition of a lease than ASC 840. The new standard requires companies to assess whether a contract contains a lease, based on whether the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
- Lease Term: ASC 840 provided limited guidance on determining the lease term. However, ASC 842 provides more detailed guidance on how to determine the lease term, including how to account for renewal options and termination clauses.
- Discount Rates: Under ASC 840, companies were required to use the implicit rate in the lease to calculate the present value of lease payments. However, under ASC 842, companies are required to use their incremental borrowing rate to calculate the present value of lease payments.
- Disclosure Requirements: ASC 842 introduces new disclosure requirements for companies, including the maturity analysis of lease liabilities, the weighted-average remaining lease term, and the weighted-average discount rate used to calculate lease liabilities.
- Transition Methods: Companies have a choice of transition methods for adopting ASC 842, including the modified retrospective approach and the full retrospective approach. The modified retrospective approach allows companies to recognize a cumulative effect adjustment to the opening balance of retained earnings on the date of adoption, while the full retrospective approach requires companies to restate comparative periods presented in their financial statements.
Final thoughts
ASC 840 and ASC 842 are two different lease accounting standards that have significant implications for companies. The transition from ASC 840 to ASC 842 means that companies are now required to recognize all leases on the balance sheet, which can have a significant impact on a company's financial statements. Companies should carefully consider their options for adopting ASC 842 and ensure that they have the necessary systems and processes in place to comply with the new standard like a lease management software.
