Accounting for Leases Under ASC 842: A Comparison of the New vs. Old Standards
- Frank Quintieri, CPA
- Mar 7
- 5 min read
Updated: Apr 25
by Frank I. Quintieri, CPA*
This whitepaper provides a comprehensive analysis of the differences in lease accounting under ASC 842 and the previous standard, ASC 840. It aims to clarify the key changes and their implications for financial reporting. The analysis is based solely on the Financial Accounting Standards Board’s (FASB) Accounting Standards Codifications (ASCs).
INTRODUCTION
The Financial Accounting Standards Board (FASB) introduced ASC 842 to improve transparency and comparability in lease accounting. This new standard replaces ASC 840 and brings significant changes to how leases are recognized and reported in financial statements. This whitepaper outlines these changes in detail, focusing on the accounting treatment for lessees and lessors.
DIFFERENCES BETWEEN THE LEASING STANDARDS
Below is a listing of the key changes made to lease accounting by ASC 842, the new leasing standard, when it replaced ASC 840 for 2019.
LEASE CLASSIFICATION
Old Standard (840)
Leases were classified as either capital or operating leases at the inception of the lease. Capital leases were recorded on the balance sheet, while operating leases were not.
New Standard (842)
Leases are classified as either finance or operating leases at the commencement date. Both types of leases are recognized on the balance sheet, with different accounting treatments for each.
BALANCE SHEET RECOGNITION
Old Standard (840)
Capital leases were included on the face of the balance sheet, while operating leases were not.
New Standard (842)
Both finance and operating leases are recognized on the face of the balance sheet. In addition, Lessees must record a right-of-use (ROU) asset and a lease liability for all leases with terms longer than 12 months, regardless of whether they are a finance or a capital lease.
LEASE MEASUREMENT
Old Standard (840)
Lease payments were recognized as expenses on a straight-line basis over the lease term for operating leases.
New Standard (842)
Lease payments are recognized based on the lease classification. For finance leases, lease liability interest, and amortization of the ROU asset are recognized separately. For operating leases, a single lease expense is recognized on a straight-line basis.
DISCOUNT RATE
Old Standard (840)
The discount rate used for capital leases was the lower of the lessee’s incremental borrowing rate or the rate implicit in the lease.
New Standard (842)
The discount rate for finance and operating leases is the rate implicit in the lease, if readily determinable, or the lessee’s incremental borrowing rate.
LEASE MODIFICATIONS AND REASSESSMENTS
Old Standard (840)
Lease modifications were generally accounted for as new leases.
New Standard (842)
Lease modifications and reassessments require remeasurement of the lease liability and adjustment of the ROU asset.
DISCLOSURE REQUIREMENTS
Old Standard (840)
Limited disclosure requirements, primarily focused on capital leases.
New Standard (842)
Enhanced disclosure requirements, including qualitative and quantitative information about lease terms, discount rates, and maturity analysis of lease liabilities.
LEASE LIABILITY VS ROU ASSET
LEASE LIABILITY
Represents the financial obligation of a lessee to make lease payments over the lease term. It is measured at the present value of the lease payments that are not yet paid, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, the lessee’s incremental borrowing rate.
ROU ASSET
Represents the lessee's right to use a leased asset for the duration of the lease term.
Although the value of the lease liability and the ROU asset are typically equal amounts at lease inception, this is not always the case. Some of the reasons they might differ are:
Initial Direct Costs
When the lessee incurs initial direct costs in relation to the leasing of the property or equipment, such as commissions or legal fees, all such costs are added to the ROU asset, but not to the lease liability.
Lease Incentives
Any lease incentives received from the lessor reduce the ROU asset, but do not affect the lease liability.
Prepaid or Accrued Lease Payments
If there are any lease payments made before the commencement date or accrued lease payments, these will adjust the ROU asset, but not the lease liability.
Impairment
If the ROU asset is impaired, its value will be reduced, but the lease liability remains unchanged.
IMPLICATIONS ON FINANCIAL REPORTING
The transition from ASC 840 to ASC 842 has significant implications for financial reporting, fundamentally altering how companies account for leases. Under ASC 840, operating leases were typically off-balance sheet items, meaning they were not recorded as assets or liabilities. However, ASC 842 requires that nearly all leases be recognized on the balance sheet, which has two important consequences.
Firstly, the recognition of operating leases on the balance sheet increases reported assets and liabilities. This change can significantly impact key financial ratios and metrics. For example, the debt-to-equity ratio may increase due to the higher liabilities, and the return on assets (ROA) may decrease because of the higher asset base. These changes can affect a company’s perceived financial health and its ability to obtain financing.
Secondly, ASC 842 enhances disclosures related to leasing activities. Companies must provide more detailed information about their lease obligations, including the nature of the leases, the terms and conditions, and the amount, timing, and uncertainty of lease payments. These enhanced disclosures provide greater transparency into an entity’s leasing activities, benefiting investors and other stakeholders by offering a clearer picture of the company’s financial commitments and operational flexibility.
CONCLUSION
ASC 842 represents a substantial shift in lease accounting, aimed at providing a more accurate representation of an entity’s leasing obligations. This whitepaper highlights the critical differences between ASC 842 and ASC 840, offering a detailed understanding of the new standard’s impact on financial reporting.
FRACTIONAL CFO CONSULTING BY CAPRI ACCOUNTING
Navigating the complexities of ASC 842 Leases can be particularly challenging for small businesses. This accounting standard, which requires companies to recognize lease assets and liabilities on their balance sheets, demands a high level of financial expertise. Capri Accounting offers Fractional CFO services to help you manage these complexities effectively.
Our Fractional CFOs provide expert financial guidance and support, ensuring your business remains compliant with ASC 842 and other accounting standards. They will assist in identifying and classifying leases, calculating lease liabilities, and ensuring accurate financial reporting. This level of expertise is typically beyond the reach of small businesses that may not have the financial bandwidth to employ a full-time CFO or CPA.
By leveraging our Fractional CFO services, you gain access to high-level accounting expertise at a fraction of the cost of employing a full-time CFO. This service is ideal for small businesses that require sophisticated financial management but need to keep costs manageable. With Capri Accounting, you can confidently tackle complex accounting tasks and make better informed financial decisions.
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