The Report Card Is In

Here Are the Most Commonly Elected ASC 842 Practical Expedients

Most public companies have completed their adoption of ASC 842, and lessees have seen their balance sheets swell. As expected, the impact of ASC 842 on other financial statements for lessees has been minimal. For those with lessor activity, the adoption of ASC 842 has not materially altered their accounting for leases. The new requirements did, however, materially affect financial statement disclosures for many lessees and lessors. In this article, we discuss the practical expedients that companies most commonly used when adopting ASC 842. Note that as of this writing, most calendar-year-end filers have not filed their 2019 financial statements.



As expected, filers frequently elected the practical expedients in ASC 842 to minimize the cost and complexity of applying the new guidance. The table above summarizes three of the most widely used practical expedients according to a Deloitte analysis of the quarterly Form 10-Q filings of 50 Fortune 125 companies from various industries. The table as well as the discussion in the remainder of this article are based on the sample of the filings reviewed as part of the Deloitte analysis.

The “package of three” practical expedients (see ASC 842-10-65-1(f)) must be elected as a package and applied consistently to all leases that commenced before the effective date for both lessees and lessors. The package consists of the following:

• An entity need not reassess whether any expired or existing contracts are or contain leases—If an entity has been correctly accounting for its existing contracts under the legacy requirements, these contracts do not have to be reevaluated (i.e., arrangements deemed to be a lease under ASC 840 would be considered a lease under ASC 842, and arrangements not deemed to be a lease under ASC 840 would not be considered leases under ASC 842).
  
  
• An entity need not reassess lease classification for any expired or existing lease—Lessees and lessors that adopt this expedient will not have to revisit their initial lease classifications. An operating lease under ASC 840 will remain an operating lease under ASC 842. Likewise, a capital lease under ASC 840 will be called a finance lease under ASC 842, but the change will be in the name only.
  
  
• An entity need not reassess initial direct costs on existing leases—For existing leases, the initial direct costs capitalized under ASC 840 also qualify for capitalization under ASC 842. This applies to expenses that will not be considered initial direct costs under ASC 842.

The “package of three” expedients were designed to significantly reduce the time and effort needed to reevaluate lease accounting decisions made under previous standards. The time and cost of preparing financial statements that meet ASC 842 transition requirements will also decrease.

The expedient related to not separating lease from nonlease components (see ASC 842-10-15-37) may be applied by lessees, as an accounting policy election, to an underlying asset class. In other words, a lessee that elects this expedient must apply it to all leases within the particular asset class, though not all asset classes must conform. Of the 75% of companies that elected this expedient, 32% stated that they did not employ the expedient for all asset classes.

This expedient calls for lessees to account for each separate lease component and the nonlease components associated with that lease component as a single lease component. This practical expedient is intended to reduce the administrative burden of separating multiple components and accounting for each one separately. The consequence of this election is that both lease and nonlease components are likely to be included in the measurement of the ROU asset and related lease liability. If the nonlease components are significant, the gross-up on the balance sheet could affect lease classification as well as covenant ratios and other financial metrics.

After the release of the new leasing standard, the FASB added a similar practical expedient for lessors (see ASC 842-10-15-42A and 15-42B) to provide relief for transition and continuing compliance. Lessors can elect this practical expedient when (1) the timing and pattern of transfer for the lease and nonlease components are the same and (2) the lease component is accounted for as an operating lease if accounted for separately. The combined component would be accounted for as either a single lease component or a single revenue component, depending on which component is predominant.

Under the short-term lease recognition exception (see ASC 842-20-25-2) that is applicable only for lessees, leases with a term of one year or less, and that do not include a purchase option whose exercise is reasonably certain, would not be subject to the recognition requirements in ASC 842; rather, such leases would be accounted for in a manner similar to an operating lease under the legacy ASC 840 requirements.

While this expedient does provide relief from balance sheet capitalization, the short-term lease costs must be disclosed. Lease payments will be recognized on a straight-line basis over the lease term. This expedient is elected by underlying asset class.

In conclusion, the three expedients most commonly elected have all achieved the FASB’s desired results: leases are recognized in lessees’ financial statements as a quantified obligation and, along with disclosures, have provided additional transparency to users. It is still too early to weigh in on the costs versus benefits of ASC 842 as a whole, but for now implementation and ongoing compliance appear to be manageable for most companies.