What is ASC 842-10-65-1’s Practical Expedient Package?

The Financial Accounting Standards Board (FASB) introduced Accounting Standards Codification (ASC) 842, Leases, to increase transparency in financial reporting. This standard replaced ASC 840 and changed how companies account for leases by requiring lessees to recognize assets and liabilities for most leases on the balance sheet. Recognizing the operational difficulties companies would face, the FASB provided transition reliefs. A primary relief, found in ASC 842-10-65-1, is a package of three practical expedients. These expedients simplify the transition by allowing companies to bypass some complex reassessments, but they must be elected as an all-or-nothing package.

The Practical Expedient Relief Package

The transition relief within ASC 842 is a package of three practical expedients that cannot be elected individually. An entity choosing to use this relief must adopt all three components and apply them consistently to all leases that commenced before the ASC 842 effective date. The package’s purpose is to reduce the cost and effort of transition by allowing entities to carry forward certain conclusions made under the previous standard, ASC 840. Without this relief, an entity would be required to perform a comprehensive review of all existing contracts against the new, more stringent definitions and requirements of ASC 842.

No Reassessment of Contract Status

The first expedient allows an entity to avoid reassessing whether its expired or existing contracts are or contain leases under the new ASC 842 definition. Under previous guidance, some arrangements treated as service contracts might now meet the definition of a lease. This expedient permits a company to carry forward its initial determination, meaning if a contract was not accounted for as a lease under ASC 840, it does not need re-evaluation. This is beneficial for companies with numerous service contracts that might contain embedded leases, as it streamlines the identification phase of the transition.

No Reassessment of Lease Classification

The second practical expedient allows an entity to forgo the reassessment of lease classification for its existing leases. Under ASC 840, leases were classified as either operating or capital leases, while ASC 842 uses operating or finance lease classifications. This expedient provides a direct transition path: leases classified as operating under ASC 840 remain operating leases, and capital leases become finance leases. This eliminates the need to apply the new classification tests, which replaced the “75% of economic life” and “90% of fair value” bright-line tests from ASC 840 with more principles-based criteria.

No Reassessment of Initial Direct Costs

The final expedient addresses the treatment of initial direct costs for existing leases. It permits an entity to not reassess whether these costs meet the revised, narrower definition in ASC 842, which defines them as only incremental costs that would not have been incurred if the lease had not been obtained. This is more restrictive than the definition under ASC 840. By electing this expedient, companies can carry forward the unamortized balance of initial direct costs capitalized under the previous rules. These costs become part of the initial measurement of the right-of-use (ROU) asset.

Accounting Implications of the Election

Electing the package of practical expedients has direct consequences for the balance sheet upon transition. For operating leases under ASC 840, the election simplifies the initial measurement of the lease liability and the corresponding ROU asset. The lease liability is calculated as the present value of the remaining lease payments. The ROU asset is then measured as the lease liability, adjusted for any remaining balance of prepaid or accrued rent and the unamortized balance of initial direct costs, and reduced by any remaining lease incentives received. This avoids the more complex full retrospective approach.

The practical expedients allow an entity to carry forward conclusions made under ASC 840, but they do not forgive known errors in the application of that previous standard. If a company is aware that a lease was misclassified or a contract was incorrectly identified under ASC 840, it cannot use the expedient to perpetuate that error. Such errors must be corrected prior to or at the time of transition. The relief is intended to ease the burden of reassessment, not to shield a company from the consequences of improper accounting.

Conversely, an entity that chooses not to elect the package faces a much more demanding transition process. Without the relief, the company must perform a full review of all its contracts to identify any embedded leases under the new ASC 842 definition. It must also reassess the classification of every existing lease using the new criteria and re-evaluate all capitalized initial direct costs against the narrower definition. This full reassessment requires significant resources, including time and specialized expertise, which highlights the value of the election decision.

Application and Disclosure Guidance

The election of the practical expedient package is a policy decision implemented during the adoption of ASC 842. It is not a form filed with a regulatory body but an internal accounting policy choice that must be properly documented. The key to its application is consistency; the package must be applied to all leases that commenced prior to the entity’s effective date for the new standard, ensuring uniform use across the applicable lease portfolio.

A requirement for any entity that elects the practical expedient package is to disclose this fact in the notes to its financial statements. ASC 842 mandates this disclosure to ensure transparency for investors and other stakeholders. The disclosure informs readers that the company used a specific transition method that allowed it to carry forward certain accounting conclusions from the previous standard. A common example of such wording would be: “In transitioning to ASC 842, the Company elected the package of practical expedients permitted under the transition guidance, which allowed the Company to not reassess whether existing contracts contain leases, the lease classification for existing leases, and initial direct costs for existing leases.”