When Was ASC 842 Effective for Private Companies?

ASC 842 represents a change in how companies account for leases, bringing more transparency to financial statements. This accounting standard provides a clearer picture of an organization’s lease obligations and the associated assets it controls. It impacts how private companies’ financial health is presented. Virtually all leases appear on the balance sheet, reflecting the economic reality of lease agreements.

Effective Date for Private Companies

Private companies initially had an effective date for fiscal years beginning after December 15, 2019. The Financial Accounting Standards Board (FASB) recognized implementation challenges for private entities.

To ease the transition, the FASB issued Accounting Standards Update (ASU) 2019-10, which deferred the effective date for private companies to fiscal years beginning after December 15, 2020. A further deferral was granted through ASU 2020-05 due to complexities. This final deferral pushed the mandatory adoption for private companies to fiscal years beginning after December 15, 2021. Private companies were required to apply ASC 842 for their calendar year 2022 financial statements, with interim periods within fiscal years beginning after December 15, 2022.

Core Requirements of ASC 842 for Lessees

ASC 842 changed lease accounting by requiring lessees to recognize most leases on their balance sheet, departing from previous guidance that allowed operating leases to remain off-balance sheet. This standard mandates the recognition of a “right-of-use” (ROU) asset and a corresponding lease liability for nearly all leases. The ROU asset represents a lessee’s right to use an identified asset for a period of time, while the lease liability represents the present value of future lease payments.

The standard distinguishes between two primary lease classifications: finance leases and operating leases, each with distinct accounting treatments. A lease is classified as a finance lease if it meets one of five criteria, such as transferring ownership or if the present value of payments constitutes substantially all of the asset’s fair value. For finance leases, the ROU asset is amortized separately from the interest expense recognized on the lease liability, resulting in a front-loaded expense pattern over the lease term.

Conversely, an operating lease does not meet any of the finance lease criteria and is accounted for differently. For operating leases, a single lease expense is recognized on a straight-line basis over the lease term, which includes both the amortization of the ROU asset and the interest on the lease liability. This approach ensures a consistent expense recognition pattern in the income statement, even though the ROU asset and lease liability are still recognized on the balance sheet. The classification dictates how the lease impacts the income statement and cash flow statement, reflecting the economic substance of the arrangement.

Transition Methods for Adoption

Upon adopting ASC 842, private companies had specific methods available for transitioning their existing lease agreements to the new standard. The primary approach was the modified retrospective method, which allowed companies to apply the new standard either to the earliest period presented in the financial statements or as of the beginning of the period of adoption. Many private companies applied the standard as of the effective date, recognizing a cumulative-effect adjustment to retained earnings. This simplified transition by not requiring restatement of prior periods.

To ease the burden of adoption, the FASB provided several practical expedients that private companies could elect. A common expedient allowed companies to avoid reassessing whether existing contracts contained a lease or would be classified differently under ASC 842. Another expedient permitted a portfolio approach for leases with similar characteristics, streamlining recognition for numerous similar assets.

These practical expedients also included an option not to separate lease and non-lease components for certain asset classes, treating them as a single lease component. Companies could also use hindsight when determining the lease term and assessing impairment of right-of-use assets, which provided flexibility in evaluating lease options and asset values. These choices aimed to reduce complexity and cost associated with initial application.

Ongoing Accounting and Reporting Considerations

After initial adoption, private companies must continue to account for their leases under ASC 842, which involves ongoing measurement and adjustments. The right-of-use asset is generally amortized over the shorter of its useful life or the lease term, while the lease liability is reduced by lease payments made and increased by the accretion of interest. This continuous process ensures that the balance sheet accurately reflects the remaining lease obligations and the value of the right to use the leased asset.

Events such as lease modifications, changes in the lease term, or revisions to the discount rate can trigger a remeasurement of both the lease liability and the right-of-use asset. For example, if a company extends a lease term, the lease liability and corresponding ROU asset must be recalculated to reflect the revised future payments and period of use. These adjustments ensure the financial statements remain current and reflective of the revised contractual terms.

Private companies are also subject to specific quantitative and qualitative disclosure requirements under ASC 842, providing users of financial statements with information about their leasing activities. Quantitative disclosures include details like lease cost components, weighted-average remaining lease terms, and weighted-average discount rates. Qualitative disclosures involve explanations of significant judgments made in applying the standard, such as assumptions used in determining the lease term or the discount rate, and information about variable lease payments or options to extend or terminate leases.