Does ASC 842 Apply to Lessors? A Comprehensive Analysis for Clarity

The implementation of ASC 842 brings about changes to lease accounting standards that directly impact both lessors and lessees. As a lessor, understanding the implications of ASC 842 on your lease arrangements can help you maintain compliance with the new accounting standards and offer insights into potential effects on your financial statements.

Under ASC 842, the accounting treatment for lessors is more of a refinement rather than a complete overhaul. Some of the key changes include the replacement of the term “rent” with “lease” in financial statements, aligning certain aspects of the lessor accounting guidance with ASC 606 (revenue recognition), and requiring your customers to recognize all leases, including operating leases, with terms greater than 12 months on their balance sheets. As a lessor, it’s crucial to familiarize yourself with these modifications and integrate them into your accounting processes to ensure smooth and effective lease management.

Incorporating ASC 842 into your accounting practices may require updates to your internal systems, documentation, and disclosures. To comply with the new standards, lessors need to provide qualitative and quantitative information about their leases, including descriptions of the leases themselves and any significant judgments made. By proactively addressing these changes and obtaining a comprehensive understanding of the ASC 842 requirements, you can confidently adapt your lease accounting practices and maintain your organization’s financial integrity.

One of the easiest ways to implement this effectively is with lease accounting software from Black Owl Systems.

Understanding Applicability: Does ASC 842 Apply to Lessors?

Key Aspects of ASC 842

As a lessor, it is crucial for you to understand how ASC 842 applies to your business. This accounting standard mainly impacts the leasing practices of both lessors and lessees. Despite the fact that lessor accounting is not fundamentally changed by ASC 842, some important differences from ASC 840 exist source.

First and foremost, ASC 842 has aligned certain aspects of lessor accounting with ASC 606, the revenue recognition standard. This alignment brings consistency between two vital areas of financial reporting, ensuring that your accounting processes are streamlined and transparent.

With the introduction of ASC 842, all leases, including operating leases with terms greater than 12 months, must now be recognized by your customers. This change in lease recognition impacts the lessees’ balance sheets and may alter the nature of your relationships with them. As a result, it is important to stay informed about these developments and adjust your leasing strategies accordingly.

In addition to the changes in lease recognition, there are specific modifications to the terminology used in financial statements. For example, the word “rent” is generally replaced with “lease,” and phrases such as “rent revenue” and “rent term” become “lease revenue” and “lease term,” respectively source.

ASC 842 also offers guidance on combining lease and non-lease components in a contract, as both lessees and lessors are permitted to do so when certain conditions are met. This allowance provides you with increased flexibility when structuring lease agreements, allowing you to better cater to your clients’ needs.

To ensure compliance with ASC 842, it’s important to regularly review your lease agreements, update your financial statements accordingly, and stay informed about relevant guidance from the FASB. By doing so, you demonstrate a commitment to transparent and consistent financial reporting, instilling confidence in your stakeholders.

Detailed Analysis on ASC 842 Lessor Accounting

In this section, we will provide a detailed analysis of ASC 842 lessor accounting and its implications for your business. We will focus on the key aspects of sales-type and direct financing leases.

Sales Type and Direct Financing Leases

ASC 842, also known as Topic 842, is a significant update to the previous lease accounting standard, ASC 840. It introduces several changes which impact both lessees and lessors, including the treatment of sales-type leases, operating leases, and direct financing leases.

Sales-Type Leases: Essentially, a sales-type lease exists when a lessor transfers control of the underlying asset to the lessee. In this scenario, the lessor records a sale of the asset, as well as the related lease receivable. The lease receivable is measured at the present value of the future lease payments, and the difference between the lease receivable and the carrying value of the asset is recognized as profit. Under ASC 842, the criteria for a lease to be classified as a sales-type lease remain similar to ASC 840; however, the focus now shifts to whether control of the underlying asset is transferred to the lessee.

Operating Leases: For an operating lease, the lessor does not recognize any profit or loss on the transaction at lease commencement. Instead, they continue to carry the underlying asset on their balance sheet, and lease revenue is recognized on a straight-line basis over the lease term. This means that under ASC 842, lessors must replace the word “rent” with “lease” in financial statements, as rent revenue becomes lease revenue, rent term becomes the lease term, and rent receivable becomes the net investment in the lease.

Direct Financing Leases: A direct financing lease is a lease in which the lessor’s only source of revenue is the interest income on the lease receivable. No profit or loss is recognized at the commencement of the lease. The lease receivable equals the net investment in the leased asset, and interest income is recognized over the lease term. To qualify as a direct financing lease under ASC 842, certain criteria must be met, such as the collectibility of the lease payments being probable, and the effectiveness of the economic life or fair value tests.

ASC 842 does not fundamentally change the accounting for sales-type and direct financing leases. However, some differences exist compared to ASC 840, largely in how these leases are identified and classified. It is essential for you to understand these differences and apply them to your lease accounting practices.

Overall, it’s important for you to familiarize yourself with the nuances of ASC 842, especially when it comes to the treatment of these specific lease types. By doing so, you can ensure that your company’s financial reporting remains accurate and compliant with the updated standards.

Lease Components and Financial Statements Implication

Regarding ASC 842, it is essential for you, as a lessor, to understand how lease components are identified and allocated in financial statements. Under this accounting standard, lease components are accounted for under ASC 842, while non-lease components, such as services related to the lease, are accounted for under other relevant GAAP.

In your financial statements, you should now generally replace “rent” with “lease.” Consequently, rent revenue becomes lease revenue, rent term becomes lease term, and so on.

The balance sheet will now reflect lease liabilities and right-of-use (ROU) assets for lessees, affecting financial ratios and other metrics. However, as a lessor, your accounting is not fundamentally changed by ASC 842, but it’s crucial to be aware of some important differences from ASC 840, as well as how ASC 842 has been aligned with the guidance in ASC 606 (Revenue Recognition).

To determine how ASC 842 affects your financial statements, be sure to consider the classification and accounting for lease and non-lease components. This will help provide a clear and accurate presentation of your financial position and performance regarding your leases.

For subsequent measurement, always follow the relevant guidance of ASC 842 or other applicable accounting standards for non-lease components. It is crucial to provide users of your financial statements with accurate and relevant information that reflects the economic reality of your lease arrangements.

By understanding the implications of lease components under ASC 842 and following the appropriate guidance, you can confidently make informed decisions and ensure compliance with the new lease accounting requirements.

The Transition from ASC 840 to ASC 842

As you navigate the transition from ASC 840 to ASC 842, it’s important to understand the key aspects that will affect lessors. ASC 842 brings about significant changes in lease accounting, impacting previous lease guidance and introducing new requirements to consider.

Under ASC 842-10-25-2, lessors must recognize lease assets and liabilities for leases previously classified as operating leases under ASC 840. This means reevaluating all your existing leases and adjusting your accounting practices accordingly. When transitioning, it’s crucial to consider any technical corrections that may arise, as well as updates to accounting standards.

One of the primary changes lessors will encounter is the treatment of lease modifications. Under ASC 842, you will need to reassess lease modifications to determine if a separate contract exists or if the existing contract should be modified. This evaluation may result in accounting changes that impact your financial statements.

During the transition, you’ll also want to pay close attention to short-term leases. Under ASC 842, lessors can elect not to recognize lease assets and liabilities for short-term leases (leases with a term of 12 months or less). This simplifies the accounting process for these types of leases and may provide practical benefits for both lessees and lessors.

To facilitate a smoother transition to ASC 842, practical expedients are available for lessors. These practical expedients can help you navigate through the complexities of the new lease accounting standard. For example, lessors can continue to recognize net investments in leases at the carrying amount under ASC 840, preventing potential distortions in the implicit interest rate.

As a lessor, considering these factors will help you adequately prepare for the transition from ASC 840 to ASC 842. By understanding the new requirements and adjusting your accounting practices accordingly, you can confidently navigate the complexities of the new lease accounting standard and maintain compliance with the updated guidance.

Greg Kautz
Greg Kautz

Greg Kautz, CPA, CMA

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