When Does ASC 842 Take Effect? Key Dates & Changes

The Financial Accounting Standards Board (FASB) introduced Accounting Standards Codification (ASC) 842 to enhance transparency in financial reporting related to lease obligations. This standard dictates how organizations following U.S. Generally Accepted Accounting Principles (GAAP) must record the financial impact of their leases. Its purpose is to provide a clearer view of financial commitments, replacing ASC 840, which allowed many lease obligations to remain undisclosed on the balance sheet. ASC 842 ensures financial statements accurately reflect an entity’s complete financial position, helping investors and stakeholders assess true obligations and compare financial performance.

Key Effective Dates

The effective dates for ASC 842 varied by entity type. Public business entities (PBEs) transitioned for fiscal years beginning after December 15, 2018, meaning most calendar year-end public companies adopted ASC 842 on January 1, 2019.

For private companies and non-public entities (NPEs), the original effective date was for reporting periods beginning after December 15, 2019. The FASB deferred this date twice, first in 2019 due to implementation complexities and again in 2020 in response to the COVID-19 pandemic. These deferrals set the effective date for private companies and non-profit organizations to fiscal years beginning after December 15, 2021. Most private companies transitioned for their 2022 fiscal year.

Fundamental Changes Introduced by ASC 842

A key shift ASC 842 brings is the requirement for lessees to recognize most leases on their balance sheet. Under ASC 840, operating leases were generally treated as off-balance sheet items, with financial obligations only disclosed in footnotes. Now, nearly all leases with terms greater than 12 months must be recognized as both a “right-of-use” (ROU) asset and a corresponding lease liability on the balance sheet. The ROU asset represents the right to use the underlying asset, and the lease liability signifies the obligation for future payments.

This change significantly impacts financial statements by increasing both total assets and total liabilities. For example, leverage ratios such as debt-to-equity and debt-to-assets typically increase, affecting a company’s perceived financial risk. Liquidity ratios, like the current ratio, may decrease if current lease liabilities grow disproportionately to current assets.

While the balance sheet sees the most significant changes, ASC 842 also affects the income statement and cash flow statement. For operating leases, a single straight-line lease expense continues to be recognized on the income statement, similar to ASC 840. For finance leases (formerly capital leases), separate interest expense on the lease liability and amortization expense on the ROU asset are recognized, often resulting in higher expenses in the earlier years of the lease term.

Transitioning to the New Standard

Companies transitioning to ASC 842 typically use a modified retrospective approach. This method allows entities to apply the new standard as of the effective date or the beginning of the earliest comparative period presented, with a cumulative-effect adjustment to equity on the initial adoption date. This approach simplifies adoption by generally not requiring restatement of prior financial data.

Preparatory actions for implementation include identifying all lease agreements, even those not traditionally labeled as leases. This involves reviewing contracts to uncover “embedded leases,” which are agreements granting control of an identified asset within broader service or supply contracts. Companies need to collect relevant data for each lease, such as start and end dates, payment terms, renewal options, and discount rates, as accuracy is paramount for calculations.

Assessing the potential impact on debt covenants is important. Many loan agreements contain financial covenants tied to ratios like debt-to-equity or interest coverage, which can be affected by increased liabilities under ASC 842. Engaging with lenders to discuss these changes and potentially renegotiate covenants is often advisable to avoid technical defaults.

Implementing new lease accounting software or updating existing processes is necessary to manage ASC 842 complexities. These systems centralize lease data, automate calculations, generate required journal entries and disclosures, and produce audit-ready reports. This technology helps ensure ongoing compliance and provides greater visibility into lease portfolios.