Lease accounting serves as a critical pillar of financial reporting, enabling businesses to accurately measure, recognize, and disclose leasing activities in compliance with regulatory standards such as the new lease accounting standard ASC 842, issued by the Financial Accounting Standards Board (FASB). The implementation of ASC 842 has brought significant changes to how leases are accounted for, requiring both operating leases and finance leases to be recorded on the balance sheet—a shift from the previous ASC 840 guidelines. This update is especially important for businesses that rely heavily on leasing, as it directly impacts lease classification, lease payments, and disclosures in financial statements. The new standard aims to increase transparency in reporting and provide stakeholders with a more accurate view of a company's lease obligations.
In this guide, we’ll explore the foundational aspects of lease accounting, delve into the specifics of ASC 842, and highlight the tools and resources available to help you navigate these complex requirements. Whether you’re new to lease accounting or looking to refine your existing processes, this resource will provide actionable insights to simplify compliance and improve your reporting practices.
Before a company can account for a lease, it first needs to determine whether an agreement meets the definition of a lease under ASC 842. The standard, issued by the Financial Accounting Standards Board (FASB), provides a clear framework for identifying lease agreements and ensuring they are properly recorded.
In simple terms, a lease is a contractual arrangement where one party (the lessee) pays another party (the lessor) for the right to use an asset over a period of time, also known as a lease term.
Under ASC 842, the standard outlines clear criteria for determining whether a contract qualifies as a lease, including the lessee’s right to obtain substantially all of the economic benefits from the use of the asset and the right to direct its use. The commencement date of the lease plays a critical role in determining when lease liability and right-of-use (ROU) asset should be recognized on the balance sheet. If a contract qualifies as a lease, the lessee must also consider the discount rate—often the incremental borrowing rate—to calculate the present value of lease payments, which helps determine the amount of the lease liability.
To meet this definition, the following conditions must be satisfied:
These criteria distinguish leases from service contracts, where control over the asset remains with the service provider. If a contract meets the lease definition under ASC 842, it must be accounted for accordingly, either as an operating lease or a finance lease (formerly known as a capital lease).
Next, we’ll explore these two lease classifications and how they impact financial reporting.
Once a lease is identified under ASC 842, the next step is to classify it correctly. ASC 842 establishes two types of leases: operating leases and finance leases (previously called capital leases under ASC 840). While both now appear on the balance sheet, their accounting treatment differs, affecting how companies recognize expenses and liabilities.
Operating leases are often used for assets that a company needs for a set period but doesn’t intend to purchase—such as office space, equipment, or vehicles. Under ASC 842, operating leases are now recorded on the balance sheet, but they are still treated differently from finance leases in terms of expense recognition.
Operating leases are often preferred when a company wants flexibility and lower financial risk, as they typically don’t transfer ownership of the asset.
A finance lease is similar to an asset purchase in that the lessee effectively takes on ownership-like risks and benefits. This classification applies if the lease meets any of the following criteria:
If any of these conditions are met, the lease must be accounted for as a finance lease.
Finance leases are more common for long-term asset use where the lessee wants ownership benefits without an immediate capital outlay.
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To summarize, operating leases are typically used for short-term or flexible leasing needs, with expenses recognized evenly over time, while finance leases resemble asset purchases, leading to ownership-like accounting treatment with higher upfront expenses.
With the introduction of ASC 842, both lease types now require on-balance-sheet recognition, increasing visibility into lease obligations for investors and stakeholders. However, the distinction between them remains important for expense recognition and financial reporting.
Next, we’ll dive deeper into lease accounting and financial statement impacts under ASC 842.
With the introduction of ASC 842, lease accounting has undergone a significant transformation, particularly in how leases appear on financial statements. The new standard enhances transparency by requiring nearly all leases to be recorded on the balance sheet, impacting a company’s financial metrics, reporting processes, and compliance requirements.
Below, we break down how ASC 842 affects the balance sheet, income statement, and cash flow statement—the three core financial statements that businesses rely on for reporting.
One of the most notable changes under ASC 842 is the requirement to recognize lease liabilities and right-of-use (ROU) assets for both operating and finance leases. Previously, only finance (capital) leases appeared on the balance sheet, while operating leases were treated as off-balance-sheet items.
Now, both lease types must be recorded as follows:
For operating leases, the ROU asset and lease liability are recorded similarly to finance leases, but they are treated differently on the income statement (explained below).
For finance leases, the asset is depreciated over time, and the liability is reduced as payments are made, just like a loan.
While both lease types now appear on the balance sheet, their expense recognition on the income statement remains distinct:
This distinction is important because finance leases tend to impact net income more in the earlier years, while operating leases maintain a steadier expense pattern.
ASC 842 also affects the classification of lease payments on the cash flow statement, which is important for companies managing liquidity and financial planning.
For businesses that rely heavily on leases, these new reporting requirements can affect key financial ratios, such as:
ASC 842 brings lease obligations into greater focus for investors, lenders, and other stakeholders. While it increases financial transparency, it also requires companies to adjust their accounting processes, ensure accurate lease tracking, and reassess financial performance metrics under the new reporting standards.
Up next, we’ll look at tools and resources that can help businesses manage lease accounting efficiently under ASC 842.
Transitioning to ASC 842 can be a complex process, especially for businesses with numerous leases to manage. To ensure compliance and streamline lease accounting, many companies are turning to specialized tools and resources designed to handle the nuances of the new standard. Below, we’ll explore some of the most effective solutions to help you stay on top of your lease accounting obligations.
Lease accounting software has become an invaluable resource for businesses adopting ASC 842. These platforms simplify the process of identifying, recording, and reporting lease data while automating compliance with the standard.
Key features of lease accounting software include:
Some of the most popular lease accounting software solutions include:
For smaller companies with fewer leases, spreadsheets can provide a low-cost alternative to specialized software. Templates are available online that are designed specifically for ASC 842 compliance, including built-in calculations for ROU assets, lease liabilities, and amortization schedules.
While spreadsheets are a good starting point, they come with limitations:
For businesses with limited lease activity, spreadsheets may suffice. However, as lease volume increases, upgrading to software is often more efficient and reliable.
Navigating ASC 842’s complexities may require guidance from a Certified Public Accountant (CPA) or a specialized accounting firm. CPAs can:
Alternatively, some businesses opt to outsource lease accounting entirely, particularly if they lack the internal resources or expertise to handle the new standard.
For companies looking to educate themselves on ASC 842, the Financial Accounting Standards Board (FASB) provides a wealth of resources, including:
Certain industries, like real estate or retail, face unique challenges under ASC 842 due to their extensive lease portfolios. Many trade organizations and industry groups offer tailored resources, including:
The right tools and resources for lease accounting depend on your business’s size, lease portfolio, and internal capabilities. Whether you choose to invest in software, rely on spreadsheets, or seek external support, having the proper systems in place will ensure you stay compliant with ASC 842 while simplifying your reporting processes.
In the final section, we’ll explore how lease accounting impacts specific industries, with a closer look at unique challenges faced by biotechnology and life sciences companies.
Lease accounting is a critical component of financial reporting across industries, and the introduction of ASC 842 has brought significant changes that require businesses to adapt. From understanding the differences between operating and finance leases to ensuring compliance with the latest standards, proper lease accounting is essential for transparency, accuracy, and informed decision-making.
While this guide focuses on lease accounting broadly, certain industries face unique challenges that warrant additional attention. For instance, biotechnology and life sciences companies often operate in highly specialized environments where leasing laboratory equipment, research facilities, and other critical assets is common. This makes lease accounting especially important for tracking financial performance and preserving working capital.
For biotech and life sciences organizations, specific considerations include:
For these companies, leveraging specialized lease accounting software or working with industry-savvy CPAs can help address these unique challenges while ensuring compliance and audit readiness.
No matter your industry, the tools and strategies outlined in this guide can help you navigate ASC 842 with confidence. By staying informed, investing in the right resources, and consulting with experts when needed, your business can not only comply with lease accounting standards but also make leasing a strategic advantage.
