What is ASC 842?
ASC 842 is the FASB standard governing how entities reporting under US GAAP account for leases. It replaced ASC 840 and requires a lessee to recognise a right-of-use asset and a lease liability for most leases, rather than leaving operating leases off the balance sheet with only the commitments disclosed.
Under ASC 840, an operating lease produced a rent expense and a note. The commitments were visible only to a reader who went looking for them. ASC 842 was written to close that gap, for the same reason the IASB wrote IFRS 16: a business that leases its premises and a business that borrows to buy them carry similar obligations and should not look entirely different in the accounts.
When did ASC 842 take effect?
ASC 842 took effect for public business entities for fiscal years beginning after 15 December 2018, which meant calendar-year adopters applied it from 1 January 2019. For all other entities it took effect for fiscal years beginning after 15 December 2021.
That staggered adoption is why private US companies were still working through first-time application several years after listed companies had finished, and why transition questions on ASC 842 surfaced later than they did for IFRS 16.
Who does ASC 842 apply to?
ASC 842 applies to entities preparing financial statements under US GAAP. For a UK organisation this usually arises in one of two ways: a UK subsidiary reporting into a US parent that consolidates under US GAAP, or a group with US operations that must prepare figures on both bases.
Dual reporting is where the differences below stop being academic. The same lease can require an IFRS 16 measurement for the statutory accounts and an ASC 842 classification for the group submission.
How ASC 842 classifies leases
A lessee classifies each lease as finance or operating at commencement. The lease is a finance lease if any one of five criteria is met, and an operating lease if none is met.
- Ownership of the underlying asset transfers to the lessee by the end of the lease term.
- The lease contains a purchase option the lessee is reasonably certain to exercise.
- The lease term is for a major part of the remaining economic life of the underlying asset.
- The present value of the lease payments and any residual value guarantee amounts to substantially all of the fair value of the underlying asset.
- The underlying asset is so specialised that it is expected to have no alternative use to the lessor at the end of the lease term.
The third and fourth criteria are not expressed as bright lines. PwC’s Viewpoint guidance notes that applying thresholds of 75 per cent of remaining economic life and 90 per cent of fair value is one reasonable approach to those tests, which is where the familiar percentages from the old standard survive in practice.
Operating and finance leases: what actually differs
Both classifications put a right-of-use asset and a lease liability on the balance sheet. The difference is entirely in what happens next.
| |
Operating lease |
Finance lease |
| Initial recognition |
Right-of-use asset and lease liability |
Right-of-use asset and lease liability |
| Income statement |
A single straight-line lease cost across the term |
Amortisation of the right-of-use asset plus interest on the liability |
| Expense profile |
Level |
Front-loaded |
| Where it is presented |
Within operating expenses |
Amortisation and interest presented separately |
| Cash flow statement |
Payments within operating activities |
Interest and principal presented separately |
| Effect on EBITDA |
Reduced, because the lease cost is an operating expense |
Protected, because amortisation and interest sit below the line |
That last row is the reason classification is examined closely on US GAAP engagements. Two companies with the same leases and the same balance sheet can report a materially different operating profit and a materially different EBITDA, purely because of how the leases were classified at commencement.
Measuring the lease liability and right-of-use asset
The mechanics will be familiar to anyone who has applied IFRS 16. The lease liability is the present value of the lease payments over the lease term, discounted at the rate implicit in the lease where that is readily determinable, and otherwise at the lessee’s incremental borrowing rate. The right-of-use asset starts from the liability and is adjusted for prepayments, initial direct costs and incentives.
Our guide to calculating a right-of-use asset and lease liability works through that arithmetic with a full example. The measurement is the same in outline; what differs under ASC 842 is how the asset is written down afterwards, because an operating lease produces a single straight-line cost rather than separate amortisation and interest.
What is exempt under ASC 842?
ASC 842 offers a short-term lease policy election. A lessee may choose, by class of underlying asset, not to recognise leases with a term of 12 months or less that do not include a purchase option the lessee is reasonably certain to exercise. Payments on those leases are recognised on a straight-line basis instead.
There is no low-value exemption equivalent to the one in IFRS 16. An organisation with a large population of small leases, laptops, printers, small equipment, therefore has less relief available under ASC 842 than the same organisation would have under IFRS 16, and the population that has to be measured is larger.
ASC 842 compared with IFRS 16 and revised FRS 102
| |
ASC 842 |
IFRS 16 |
FRS 102 from 2026 |
| Lessee model |
Dual. Operating or finance |
Single |
Single |
| Most leases on balance sheet |
Yes |
Yes |
Yes |
| Short-term relief |
Policy election by asset class |
Exemption available |
Exemption available |
| Low-value relief |
None |
Available |
Available, with examples of what is not low value |
| Operating lease expense |
Single straight-line lease cost |
Not applicable. Depreciation and interest |
Not applicable. Depreciation and interest |
| Discount rate |
Rate implicit in the lease, otherwise incremental borrowing rate |
Rate implicit in the lease, otherwise incremental borrowing rate |
Obtainable borrowing rate permitted |
| Lessor accounting |
Classification retained |
Largely unchanged |
Largely unchanged |
For a UK reader the practical summary is this. If you already understand IFRS 16, you understand most of ASC 842. What you have to add back is the classification test, the two expense patterns that follow from it, and the absence of a low-value exemption.
Managing ASC 842 alongside IFRS 16 or FRS 102
Dual reporting is the hardest part of ASC 842 for organisations outside the United States. The same lease population has to be measured under one framework for the statutory accounts and classified under another for the group submission, with two sets of postings and two sets of disclosures drawn from one set of contracts.
This is where spreadsheets break down first. Maintaining one model is manageable. Maintaining two, kept in step through every modification and remeasurement, is where errors enter and where audit questions concentrate.
FMIS lease accounting software is built for lessee financial accounting under IFRS 16, ASC 842 and revised FRS 102. It maintains the lease population, calculates lease liabilities and right-of-use assets, handles modifications and remeasurements, produces reporting, posts to the general ledger, and links right-of-use assets with FMIS Fixed Assets.
| SCOPE
FMIS Lease Accounting supports lessee financial accounting. It does not provide lessor accounting, and it is not a broad operational lease administration system. |
