1.1 Background

For many reporting entities, leasing is an important way to obtain access to property. Leases provide businesses with flexibility and cost-effective options for acquiring assets without the need for upfront purchase. In 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, which introduced significant changes to lease accounting. These changes, known as ASC 842, have brought about new requirements and guidelines for reporting leases.

Understanding ASC 842

ASC 842 is a comprehensive accounting standard that aims to improve transparency and comparability in lease reporting. It applies to both lessees and lessors and requires them to recognize and measure leases on their balance sheets. The standard defines a lease as a contract, or part of a contract, that conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

Differences between ASC 842 and IFRS 16

ASC 842 and International Financial Reporting Standard (IFRS) 16, which is the equivalent standard issued by the International Accounting Standards Board (IASB), share similar objectives but differ in certain aspects. The key differences between ASC 842 and IFRS 16 lie in the recognition and measurement of lease liabilities and lease assets. It is important for organizations to understand these differences to ensure compliance with the applicable accounting standards.

A Complete Guide to ASC 842 Journal Entries: ASC 842 with Examples

Journal entries play a crucial role in lease accounting under ASC 842. They help organizations record and track the financial impact of leases on their balance sheets, income statements, and cash flow statements. In this complete guide, we will explore ASC 842 journal entries in detail, including examples for both operating leases and finance leases.

What is ASC 842?

ASC 842 is the latest lease accounting standard issued by the FASB. It replaces the previous standard, ASC 840, and introduces significant changes in how leases are reported and accounted for. ASC 842 requires lessees to recognize lease liabilities and corresponding right-of-use (ROU) assets on their balance sheets for most leases. It also introduces new disclosure requirements to provide users of financial statements with more information about leases.

What are the Two Types of Leases Under ASC 842?

ASC 842 classifies leases into two types: operating leases and finance leases. The classification of a lease depends on the extent to which the lessee controls the use of the underlying asset and the economic benefits derived from it. Operating leases are similar to rental agreements, while finance leases are more akin to asset purchases.

What are the ASC 842 Journal Entries?

ASC 842 requires lessees to record journal entries to reflect the initial recognition, subsequent measurement, and derecognition of lease liabilities and ROU assets. The journal entries vary depending on whether the lease is classified as an operating lease or a finance lease. Let's explore the ASC 842 journal entries for both types of leases.

What is the ASC 842 Journal Entry for Operating Leases?

For operating leases, lessees are required to record the following journal entries:

• Initial Recognition: Debit ROU Asset and Credit Lease Liability
• Subsequent Recognition: Debit Lease Expense and Credit Cash
• Derecognition: Debit Lease Liability, Debit Accumulated Depreciation, and Credit ROU Asset

What is the ASC 842 Journal Entry for Finance Leases?

For finance leases, lessees are required to record the following journal entries:

• Initial Recognition: Debit ROU Asset and Credit Lease Liability
• Subsequent Recognition: Debit Interest Expense, Debit Depreciation Expense, and Credit Cash
• Derecognition: Debit Lease Liability, Debit Accumulated Depreciation, and Credit ROU Asset

How Do You Account for Sale-Leaseback Transactions?

ASC 842 provides specific guidance on accounting for sale-leaseback transactions. In a sale-leaseback transaction, a lessee sells an asset to a lessor and then leases it back. The accounting treatment for sale-leaseback transactions depends on whether the transaction qualifies as a finance lease or an operating lease.

How Do You Account for Lease Incentives?

ASC 842 requires lessees to account for lease incentives received from lessors. Lease incentives can include rent holidays, reduced lease payments, or cash payments. Lessees should reduce the lease liability and recognize the lease incentive as a reduction of lease expense over the lease term.

Is Equity Affected Under ASC 842?

ASC 842 has an impact on equity due to the recognition of lease liabilities and ROU assets on the balance sheet. The increase in lease liabilities reduces equity, while the recognition of ROU assets offsets this impact to some extent. It is important for organizations to consider the equity implications of ASC 842 when reporting their financial statements.

1.3 Comparison of ASC 842 and ASC 840

ASC 842 introduced significant changes to lease accounting compared to its predecessor, ASC 840. Some of the key differences between ASC 842 and ASC 840 include the recognition and measurement of lease liabilities and lease assets. Figure LG 1-2 provides a summary of the significant differences between the two standards.

Finance vs Operating Leases: What's the Difference?

Understanding the difference between finance leases and operating leases is crucial for organizations when accounting for leases under ASC 842. Finance leases and operating leases have distinct characteristics and accounting treatments. In this guide, we will dive into everything finance vs operating leases, including examples of each and which type of lease is better suited for different situations.

Finance Leases

Finance leases, also known as capital leases, are leases where the lessee assumes substantial risks and rewards of ownership. Under ASC 842, finance leases are recognized on the lessee's balance sheet as both a lease liability and a corresponding right-of-use (ROU) asset. Finance leases are often used for assets that have a long economic life and provide significant value to the lessee over time.

Operating Leases

Operating leases, on the other hand, are leases where the lessee does not assume the risks and rewards of ownership. Operating leases are similar to rental agreements, where the lessee has the right to use an asset for a specific period but does not have ownership rights. Under ASC 842, operating leases are not recognized on the lessee's balance sheet as lease liabilities and ROU assets. Instead, lease payments are recognized as lease expense over the lease term.

Conclusion

ASC 842 has brought about significant changes to lease accounting, requiring organizations to record and report leases differently than under the previous accounting standard, ASC 840. It is crucial for businesses to understand the requirements of ASC 842 to ensure compliance and accurate financial reporting. By properly accounting for financing leases under ASC 842, organizations can provide stakeholders with transparent and reliable information about their leasing activities.