November 28, 2022
Snapshot Summary of GAAP Lease Accounting for Lessees
In Accordance with ASC 842
A lease is a contract whereby a lessor (owner or landlord) agrees to provide a lessee (user or tenant) the right to control the use of an identified asset for a specific period of time, in exchange for consideration (rent).
Accounting Standard Codification (ASC) 842 replaces the previous lease guidance (ASC 840) and aims to increase visibility into an entity’s leasing obligations to users of financial statements. Under ASC 842, lessees are required to recognize most leases on their balance sheets. ASC 842 is effective for nonpublic entities for periods beginning after December 15, 2021 and, depending upon transition guidance elected, may require a prior period restatement.
Balance Sheet Impact
The lease standard classifies leases for lessees as either operating or finance leases with both classifications of leases being recorded on the balance sheet, with few exceptions (e.g. short-term leases with terms equal to 12 months or less). Most leases under the new guidance will record a lease liability with a corresponding right-of-use (ROU) asset on the balance sheet.
Equal to the present value of the remaining lease payments. For an individual lease contract, the liability should be discounted using the rate implicit in the lease if readily determinable. If the rate is not readily determinable, the borrowing rate of the lessee may be used or an entity may elect, as an accounting policy, to use the risk free rate by class of underlying asset. Non-public entities are permitted to use a risk-free rate, which is generally the rate of a US Treasury Bill for a term equivalent to the lease term, if the election is made consistently by class of underlying asset. Subsequent to the commencement date, the lessee reduces the lease liability for lease payments made.
Equal to the initial measurement of the lease liability, plus lease payments made to the lessor at or prior to the commencement date, less lease incentives received, plus initial direct costs incurred by the lessee. At each reporting date, entities are required to test ROU assets for impairment using the impairment guidance in ASC 360.
At the date of a modification or reassessment, the lessee is required to reassess the lease, which could result in a reassessment of the ROU asset and lease liability to incorporate changes in terms (such as renewal or termination options) considered reasonably certain to exercise. Actual lease endorsements during the year will generally result in a lease reassessment.
Income Statement Impact
Under the lease standard, operating lease expenses flow through the income statement as a single line item on a straight-line basis. Finance leases recognize interest and amortization expenses in the income statement consistently with other amortization and interest expenses. Interest expenses from finance leases are typically front-loaded due to the separate interest on the lease liability.
ASC 842 also requires new disclosures in the footnotes to the financial statements.
Questions? If you have questions on how to account for leases under the standard, see our White Paper for additional details about ASC 842 or contact a member of our team.