Before You Start

This guide assumes you have access to lease agreements and a strong understanding of present value calculations.

Overview

60 min
Estimated Time
Expert
Difficulty
Quarterly
Review Frequency

What You’ll Learn

  • How to identify leases under ASC 842
  • Calculating the Right-of-Use (ROU) asset and lease liability
  • Required journal entries for operating and finance leases
  • Disclosure requirements and ongoing lease management

1. ASC 842 Fundamentals

ASC 842 significantly changes how companies account for leases, particularly operating leases, by requiring them to be recognized on the balance sheet.

Key Definitions

  • Right-of-Use (ROU) Asset
  • Lease Liability
  • Lease Term
  • Discount Rate

Exclusions

  • Short-term leases (≤ 12 months)
  • Leases of intangible assets
  • Leases of inventory

2. Lease Classification: Operating vs. Finance

Proper lease classification is critical as it dictates the accounting treatment.

Operating Lease

This lease type allows the lessee to use an asset without taking on substantially all the risks and rewards of ownership.

Pros:
  • Expense recognized straight-line.
  • Simpler P&L impact.
  • No asset ownership transfer.
Cons:
  • Still requires ROU asset and lease liability.
  • Impacts balance sheet ratios.
  • Limited tax benefits for ownership.

Finance Lease

This lease type effectively transfers substantially all the risks and rewards incidental to ownership of an underlying asset to the lessee.

Expert Tip: Correctly classifying your leases (Operating vs. Finance) is the most critical step. Misclassification can lead to significant restatements and non-compliance.

3. Step-by-Step: ROU Asset & Lease Liability Calculation

Here is the high-level workflow for calculating initial lease values.

Here is a sample code block to show how a lease data structure might look.

{
  "lease_id": "LSE-001",
  "lease_term_months": 60,
  "monthly_payment": 2500.00,
  "discount_rate_annual": 0.05,
  "initial_direct_costs": 500.00,
  "lease_incentives": 100.00
}

4. Initial Measurement & Journal Entries

  1. 1

    Determine Lease Term & Payments

    Identify the non-cancelable lease term and all fixed, variable, and residual value payments.

  2. 2

    Select Discount Rate

    Use the rate implicit in the lease, or if undeterminable, the lessee’s incremental borrowing rate.

  3. 3

    Calculate Lease Liability

    This is the present value of the future lease payments, discounted at the chosen rate.

  4. 4

    Calculate ROU Asset

    The ROU asset equals the lease liability, adjusted for initial direct costs, lease incentives, and prepaid/accrued lease payments.

Common Error: Incorrect Discount Rate

Ensure you use the correct discount rate (implicit or incremental borrowing rate) to avoid misstating the lease liability and ROU asset, which will impact your financial statements.

5. Ongoing Accounting & Disclosures

Compliance Checklist

  • Adjust ROU Asset for impairment annually
  • Recognize interest expense (finance lease) or straight-line lease expense (operating lease)
  • Prepare required footnotes disclosures for qualitative and quantitative data
  • Perform annual recalculations for changes in lease terms or conditions

Need Help?

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Navigating ASC 842 can be complex and time-consuming. Our team of accounting experts is here to help ensure your compliance and simplify your workload.

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