ASC 842 lease accounting: A complete guide for businesses

Key takeaways

Enhanced financial transparency: ASC 842 mandates that all leases be recognized on the balance sheet, significantly increasing the transparency of a company's financial obligations and providing a more accurate picture of financial health.
Consistency and comparability: The standard ensures a consistent approach to lease accounting across entities, facilitating easier comparison of financial statements, and providing a fuller view of an organization's leasing activities.
Streamlined lease accounting with NetLease for NetSuite: NetLease for NetSuite offers a robust solution that simplifies lease management. This tool functions natively within your NetSuite instance, providing automated lease tracking, robust reporting, and scalable architecture to support business growth.

Lease accounting is heavily regulated by the Financial Accounting Standards Board (FASB), and it can feel overwhelming to ensure all your leases comply with current standards. One such standard that has significantly impacted lease accounting in recent years is ASC 842.

This post provides a practical overview of the ASC 842 standard and its implications for your accounting processes. We'll cover the essentials of lease classification, recognition, measurement, and how Netgain’s solutions can help you comply with these new requirements efficiently.

What is ASC 842?

ASC 842, also known as the Accounting Standards Codification Topic 842, replaced the previous leasing standard, ASC 840. It aims to improve financial reporting of leasing transactions. ASC 842 requires organizations to recognize lease assets and lease liabilities on the balance sheet and to disclose key information about leasing arrangements.¹

The main objectives of ASC 842 are to:

Increase transparency: By bringing most leases onto the balance sheet, ASC 842 enhances the transparency of an organization's financial commitments.

Improve comparability: The standard provides a more faithful representation of an organization's leasing activities, making it easier to compare financial statements across entities.

Provide a fuller financial picture: It ensures that users of financial statements have a complete view of the organization's leasing obligations.

Learn more about the history of ASC 842 and how it differs from the previous standard, ASC 840.

Key changes in lease accounting with ASC 842

ASC 842 introduces significant changes compared to the previous lease accounting standard, ASC 840.² The notable changes include:

Recognition of all leases on the balance sheet: Under ASC 842, lessees must recognize both finance leases and operating leases as assets and liabilities on the balance sheet.

Increased lease disclosures: The new standard requires enhanced disclosures related to lease terms, lease payments, and any variable lease payments.

Present value calculations: ASC 842 requires accountants to calculate the present value of lease payments and record them as lease liabilities.

Impacts on financial ratios: Recognizing lease liabilities on the balance sheet may affect financial ratios and key performance indicators (KPIs) used for analysis and decision-making.

Scope of ASC 842

Let’s take a closer look at what ASC 842 covers.

What types of leases are covered under ASC 842?

ASC 842 applies to both lessees and lessors and covers almost all leasing arrangements, including real estate leases, equipment leases, and even certain service contracts with embedded leases.³ It clarifies what qualifies as a lease and provides guidelines on how to account for leases accurately. The standards ensure consistency and transparency across different industries and organizations.

Are there exceptions or exemptions under ASC 842?

ASC 842 provides practical exemptions for short-term leases (leases with a term of 12 months or less) and leases of low-value assets. These exemptions allow simplified accounting treatment.

How does ASC 842 change the accounting treatment of leases?

ASC 842 fundamentally alters the accounting treatment of leases by requiring lessees to recognize lease liabilities and right-of-use (ROU) assets on their balance sheets. This change aims to provide a more accurate depiction of a company's financial health by bringing leases previously kept off the balance sheet into the spotlight.

Who is affected by ASC 842, and which organizations need to comply?

Virtually all industries and sectors are impacted by this standard. Private and public companies, nonprofit organizations, and government entities that engage in lease transactions must comply with ASC 842.

What does ASC 842 mean for your financial reporting?

Implementing ASC 842 brings numerous benefits for accountants, including:

Increased transparency: By bringing all leases onto the balance sheet, ASC 842 provides a more accurate representation of a company's financial health.
Better decision-making: Having a comprehensive view of lease obligations helps accountants make informed decisions regarding lease renewals, expansions, or terminations. ‍
Enhanced risk management: Identifying lease obligations allows accountants to proactively manage and mitigate risks associated with lease agreements. ‍
Improved financial reporting: ASC 842 helps accountants generate more accurate and reliable financial statements, enhancing credibility with stakeholders. ‍
Streamlined audits: With leases appropriately recorded on the balance sheet, audits become more efficient and less prone to errors or omissions.

Ready to transition to the ASC 842 lease accounting standard? Download our free ASC 842 Transition Guide for an in-depth understanding of how to adopt the standard.

ASC 842 compliance checklist

To ensure your leases comply with ASC 842, use the following checklist:

Identify all lease contracts within your organization.
Evaluate and classify leases as finance or operating leases.
Calculate the present value of lease payments and record them as lease liabilities.
Recognize the ROU assets on the balance sheet.
Establish robust processes and controls to maintain accurate lease data.
Provide enhanced lease disclosures as mandated by ASC 842.

The right lease accounting software can help you streamline lease management and reporting, so you can rest easy that your leases comply. Let’s explore how software can help.

Software for ASC 842 lease accounting

When transitioning to ASC 842, selecting the right software for your organization can make compliance easier. As you evaluate lease accounting software, consider the following features:

Automated lease management: Automated lease management can help streamline the transition process and ensure accuracy and compliance.
Reporting: Robust reporting capabilities are essential for understanding and tracking the impact of the new standards.
Embedded solutions: Solutions that are native to your ERP help you consolidate your tech stack and reduce the time wasted switching between systems.
Integration capabilities: Integration capabilities are key to ensuring accuracy and compliance. The software should be able to integrate with other systems to ensure data accuracy and consistency.
Security and scalability: The software should have strong security measures in place to protect your data and should be able to scale as your organization grows.

Not sure if your current accounting software meets your needs? Use our accounting software evaluation checklist to find out.

For a solution that encompasses these features, check out NetLease for NetSuite. This comprehensive tool is designed to tackle the challenges of ASC 842 and is fully embedded in NetSuite, offering robust data protection and the flexibility to scale with your business.

Emerging lease accounting trends

Accounting is constantly evolving, and with new technologies on the rise, that evolution is moving faster than ever. Looking ahead, we can expect the following trends in lease accounting:

Increased automation: Lease accounting software solutions will continue to evolve, further automating manual tasks and improving efficiency. New technology can also help businesses navigate the current accountant shortage.
Enhanced lease data management: Organizations will focus on implementing robust systems and processes for managing lease data to ensure accuracy, compliance, and easy retrieval.
Ongoing regulatory changes: Lease accounting standards may undergo further updates or refinements to address emerging challenges and align with changes in the business landscape.

Unlock the future of lease accounting with Netgain

ASC 842 brings transparency, accuracy, and consistency to financial reporting, providing a clearer picture of a company's financial health. By adhering to ASC 842, companies can improve decision-making, manage risks effectively, and enhance overall financial statement credibility.

At Netgain, we understand the complexities of lease accounting and the importance of compliance. Our product suite focuses on creating solutions that simplify and automate compliance, finance, and accounting challenges.

Our lease accounting software, NetLease for Netsuite, streamlines lease management for businesses, simplifying compliance and automating processes. It helps you seamlessly navigate ASC 842, ensuring compliance while emphasizing controls and auditability.

Request a personalized demo today to discover how NetLease addresses the increased intricacies of lease accounting with a straightforward yet robust solution.

Frequently asked questions about ASC 842

Are there any industry-specific considerations under ASC 842?

Yes, ASC 842 may have industry-specific nuances that can affect the way lease accounting is implemented. Certain industries, such as retail, may have unique lease terms or arrangements that require special attention in compliance with the standard.

How often does ASC 842 require a reassessment of lease contracts?

ASC 842 mandates that lessees regularly reassess lease contracts. If there are changes in lease terms or conditions, these need to be accounted for and reflected in the financial statements.

What are the implications of non-compliance with ASC 842?

Non-compliance with ASC 842 can have serious consequences, including misrepresentation of financial statements, potential legal issues, and damage to an organization's reputation. It's crucial for organizations to adhere to the standard to maintain financial integrity and transparency.

What criteria define a short-term lease under ASC 842?

A lease is considered short-term under ASC 842 if its term is 12 months or less and does not include a purchase option that the lessee is reasonably certain to exercise.

Sources:

¹Weidner, D. J. (2017). New FASB Rules on Accounting for Leases: A Sarbanes-Oxley Promise Delivered. The Business Lawyer, 72(2), 367–404. https://www.jstor.org/stable/26419131
² Cheng, C., Geng, Y., & Zhao, S. (2022). Operating Leases and the Market’s Assessment of Equity Risk: Evidence from the Adoption of ASC 842. https://business.columbia.edu/sites/default/files-efs/imce-uploads/ADP/Agnes%20Cheng%20Geng%20Zhao%20202209.pdf
³ Gibson, Y. S. (2021). The New Lease Accounting Standards (Topic 842): An Empirical Analysis of Its Impacts on Key Financial Performance Metrics. Doctoral Dissertations and Projects. https://digitalcommons.liberty.edu/doctoral/3143/