Navigating ASC 842: Key Challenges and Solutions for Lessors Introduction

While ASC 842 does not fundamentally overhaul lessor accounting, it introduces critical updates that require finance teams to reassess their processes. From aligning with ASC 606 to expanded disclosure requirements and new lease classification rules, lessors must navigate increased complexity to ensure compliance and financial accuracy.

In this blog, we explore the key changes under ASC 842, the biggest challenges lessors face, and best practices to address them effectively. And learn how lease accounting software and lessor accounting software can simplify this process.

1. Lease Classification Updates: Same Framework, New Challenges

ASC 842 retained the sales-type, direct financing, and operating lease model, but several important changes impact how lessors classify leases:

• Collectibility Considerations: Under ASC 842, if collectibility of lease payments is not probable for a direct financing lease, a lease must be classified as an operating lease rather than a sales-type or direct financing lease. This limits upfront revenue recognition and affects financial performance.
• Variable Lease Payments: Previously, a lease with significant variable payments could not be classified as sales-type or direct financing, even if it resulted in a Day 1 loss. Under ASC 842, such leases may be classified as operating leases, reducing financial statement volatility.
• Practical Impact: These changes affect credit risk assessments, requiring lessors to refine their lease structuring to avoid unfavorable classification shifts.

Best Practice: Strengthen credit assessment procedures and ensure documentation supports collectibility conclusions before lease classification. Consider leveraging lessor accounting software to automate these assessments and maintain detailed records.

2. Revenue Recognition and ASC 606 Alignment

ASC 842 aligns lessor revenue recognition with ASC 606, requiring greater separation between lease and non-lease components.

• Lease vs. Non-Lease Components: Lessors must separate the right to use an asset from other performance obligations (e.g., maintenance, services) and allocate revenue accordingly.
• Practical Expedient: If the lease component is operating and revenue patterns align, lessors can combine lease and non-lease components to simplify accounting.
• Variable Lease Payments: Lessors cannot include variable lease payments in the net investment in the lease unless they are based on an index or rate.

How Lease Accounting Software Can Help

Navigating these complexities can be challenging without the right tools. Lease accounting software designed for lessors can help automate these processes, ensuring accuracy and compliance. Here’s how:

• Automated Lease Classification: Software can automate the classification process based on your specific criteria, reducing the risk of errors.
• ASC 606 Alignment: Lessor accounting software can help separate lease and non-lease components, ensuring proper revenue recognition.
• Detailed Reporting and Disclosures: Generate accurate reports and disclosures required by ASC 842 with ease.
• Improved Efficiency: Streamline your lease accounting processes, saving time and resources.

Conclusion

ASC 842 introduces significant changes for lessors, but with the right approach and tools, compliance is achievable. By understanding the key challenges and implementing best practices, you can navigate these changes successfully. Investing in robust lease accounting software and lessor accounting software can further simplify the process, ensuring accuracy, efficiency, and compliance.