Tax Implications of ASC 842: Lease Accounting Standards


The FASB ASC 842 Lease Accounting changes, which became effective at the end of 2021 for all reporting periods after December 15th 2021, haven’t just changed how leases are handled in books, but also the tax implications that may come along with it.  

There are seven key areas where lease accounting tax implications are impacted. Here, we’ll discuss those seven areas in detail to give you an overview of what’s going on.  

Tax Implications of ASC 842 Changes 

1. Accounting Methods 

This goes without saying that while there are some areas that won’t require as many changes, others may require definite changes. The lease accounting structure needs to be revisited in terms of tax accounting because of the potential change in: 

  • Characterization of leases 
  • Timing of lease 
  • Timing of income 
  • Tenant allowances (general treatment) 
  • Valuation allowance 
  • Lease acquisition costs (general treatments and borrowing costs) 

2. Deferred Taxes – DTA and DTLs 

According to the changes in ASC 842, operating leases should now be recorded as right-of-use (ROU) assets, and will host a corresponding lease liability as well. This will result in book-to-tax items requiring reconciliation from book keepers, specifically having to revisit the new deferred tax liabilities (DTL) and deferred tax assets (DTA).  

This is a temporary change and will reverse over the leases life.  

3. State/Local Taxes 

The new standard requires lease-related ROU assets to be recorded and may therefore increase an organizations’ balance sheet, presenting an ‘inflated statement’, which in turn, may lead to an increase in the taxes. 

This is dependent on state requirements on determining income tax. 

4. Transfer Pricing 

Since lease assets (ROU only) will need to be recorded in the financial statements of organizations, there is a good chance that bookkeepers will have to revise transfer pricing arrangements to adhere to the “arm’s length” standard.  

The chance in financial ratios and profit level indicators will impact the standard directly. 

5. Foreign Taxes 

This is one tax implication that almost everyone was prepared for; the effect on foreign country income tax.  

Just like state and local income taxes depend on where company operations are taking place, the new standard’s requirement for ROU assets being recorded will have a similar impact on foreign country income tax. This bit is mostly dependent on the tax environment of the country where a company, its branch or subsidiary is located.  

6. Property Taxes 

Another impact on leases that will be a result of state, local or foreign tax environment will be property tax levied on leased assets. If ROU assets are considered tangible personal property, property taxes will also be implemented on the assets. 

7. Sales-and-Use Taxes 

Depending on whether local, state or foreign tax environment treats the lease transaction as a taxable purchase or not, organizations may have to pay sales tax on said leases as well. This will also reflect directly on the books 

ASC 842 can get very complicated, especially now that new changes are being implemented. If not handled properly, chances are that you may end up being subject to audit objections. iLeasePro is a lease accounting software that considers all the latest changes and gives you clean, comprehensible and audit-ready books quickly. 

To schedule a free demo, get in touch with us today!  

Effective Dates of ASC 842 Changes & Transition Approach

We have extensively discussed how the implementation of ASC 842 (Lease Accounting) will impact the current and future books of companies across the board who are following GAAP principles. The goal of these changes is to streamline lease accounting, but the implementation process itself is rather complicated – especially if done manually.  

FASB has offered several reliefs to organizations transitioning, which also includes shift of transition dates from December 31st, 2019 to December 31st, 2021. In this article, we will take a closer look at those effective dates and the transition approaches companies have at their disposal. 

Effective Dates of ASC 842 

FASB has thus far given organizations (referred to as entity in their notices) a lot of leeway, considering the complexity of the task. During the transition phase, entities can choose whether they want to apply the changes in ASC 842 on the effective date, recognizing the effect in their opening balance of the next year (in their equity), or a comparative option.  

In the first option, i.e. the Effective Data Option, any and all adjustments made to their opening balance (equity) will report comparative figures (respective to periods) in the financial statement according to legacy GAAP, i.e., in accordance with the older version of ASC 842.  

On the other hand, if an organization chooses to go with the Comparative Option, they can choose to elect the new changes in each topic at the beginning of the next period. The cumulative adjustment that will be presented because of this change will therefore be adjusted in the opening balance (equity) of the new period. 

The effective dates for these changes are as follows: 

  • For Public business entities, the effective date for application of ASC 842 stood at December 15th, 2018, and the interim periods within that year. 
  • For other entities, including public business entities that are not for profit entities or have conduit debt and employee benefit plans that need to be filed with the Securities and Exchange Commission, the final date for applications of ASC 842 stood at Dec. 15, 2019
  • Due to the complexity presented by the implementation along with further changes being discussed, FASB chose to defer effective dates for entities other than public entities (mentioned in point 1) to 2020 via ASU 2020-05. These dates were first deferred to December 15, 2019, but now for “other entities” the date has been deferred to fiscal years that will start after December 15, 2021. The same is applicable for interim periods that will start after December 15, 2022
  • Despite these dates, entities are permitted – and even encouraged – to implement the changes early on. 

There are several transition reliefs that FASB has offered to the transitioners – especially those transitioning early. These include optional accommodations (elected as a package), lease renewals and purchase options and land easements that we will discuss in a separate article. 

Impacts of COVID-19 on Lease Accounting (ASC 842)


As the world continues to grapple with an invisible enemy, our daily lives aren’t all that have been impacted. Companies as a whole have been unable to collect or pay rent on their leased assets, while the changes in ASC 842 have meant that lease accountants all over the globe following GAAP have had to go through their books thoroughly to implement these changes. 

This is most prevalent in the case of lessees as they had to restructure their accounting methodologies, not to mention having to deal with lessors and agreeing to delay or decrease lease paymentsA  reduction in the right of use of leased asset isn’t out of the question either.  

Without the right lease accounting software, accountants may have to spend days on end to create workarounds and make compliance-related adjustments. Some areas that have seen significant impacts on lease accounting are listed below.  

Impact of Coronavirus on Lease Accounting 

Rent Concessions 

Due to the economic impact of COVID-19, lessees have been resorting to asking for rent concessions due to unforeseen circumstances. The force majeure clause (where present) has been implemented, and relief has been granted.  

However, where there is no such clause, rent concessions will have to be treated as a lease modification, and therefore re-measurement of lease accounting calculations.  

Incremental Borrowing Rate (IBR) 

Regulators are dropping interest rates due to the Coronavirus, and as per ASC 842’s discussion about a specific IBR, interest rates will have to be changed for right-of-use (ROU) assets and overall liabilities. This directly impacts the lessee’s balance sheets.  

Fair Market Values 

It is no secret that almost every asset – be it machinery, property or even labor costs for installation (ASC 360 provision for installation costs) – have seen considerable changes. Some are going up, some are going down. The change in fair market values needs to be compared to NPV (net present value) of any revaluated or impaired asset, and therefore a change in lease classification may be needed.  

Termination/Abandonment of Leases 

Since the pandemic has impacted business functionality, it means that some leased assets no longer serve any purpose for the business. In that case, many leases have the option of early termination. If there is no such option, the lease will have to be abandoned. In this case, the organization retains liability of the lease amount. 

Regardless of the clause, the impact will need to be recorded in the books, along with complete documentation to auditors and disclosure in the books. 

All of this can be extremely difficult if done manuallyiLeasePro can help you implement such changes in very little time and financial investment. To discuss options, get in touch with us or schedule a free demo today! 

Embedded Leases within a Contract Under the ASC 842 Standard

Lease contracts under ASC 842 We previously discussed how FASB had discussed changes in ASC 842: Lease Accounting in Rate Implicit in the lease as well as the determination of IBR. The board has also outlined the concern presented by some preparers about the identification of leases embedded within a contract.   The main issue was that entities spent significant amounts of time trying to identify and account for leases already embedded into contracts. ASC 842 requires entities to recognize and report all operating leases – both assets and liabilities – as and when the lease commences.   The Problem  ASC 842 suggests that if any contract includes a lease as identified under ASC 842 or simply gives a party the right to control property and reap the benefits and bear losses from the same in exchange for consideration (for a fixed amount of time), it needs to be recorded as a lease in the company’s balance sheets.   Since there are a large number of potential lease contracts, the manual mode of recognition of these “embedded leases” is a costly venture for preparers.  Entities often set a minimum threshold for the recognition of lease assets or liabilities – below which they are treated as immaterial, and therefore, just an expense in the Income Statement. This is an acceptable approach for FASB, since it makes the implementation of ASC 842 easier.  Having said that, the minimum threshold remains a matter of entity preference and therefore, a source of inconsistencies.  Alternatives Proposed  When exploring options about the need for a change in ASC 842 requirements for embedded leases, FASB proposed three alternatives: 
  1. No change. 
  2. Implementation of a “qualitative” minimum threshold. Here, if an embedded lease doesn’t represent the majority of a contract, it doesn’t have to be reported.  
  3. Implementation of a “quantitative” minimum threshold. Here, if an embedded lease doesn’t exceed $5,000 when new.  
When the alternatives were discussed among members, preparers, users and representatives, the following arguments came forward.  
  1. Since the recognition of embedded leases isn’t new under ASC 842, most entities already have some process implemented to review and identify them. However, it’s when recognizing leases and liabilities as operating leases that the new processes will be needed, which is why the first alternative seemed viable to many. Furthermore, Update 2016-02 of ASC 842 on the materiality of a lease has already been discussed.  
  2. The second and third alternatives, both gained some sympathy from participants – especially those representing non-public entities, but there was a concern that if a qualitative or quantitate threshold is used, it may give rise to the practice of shaping contracts in a way as to prevent it from falling under ASC 842.  
The Decision  All three alternatives were favored and not favored equally by those in the conference. The quantitative threshold implementation was most favored since it would improve convergence with IFRS 16: Lease Accounting. However, it was also determined that convergence doesn’t necessary mean easy implementation of said threshold. It would duplicate the thresholds already established under ASC 842.   Implementing either the qualitative or quantitative threshold would demand an update over time. Right now, entities need to show why the current threshold is appropriate, something that would not be possible if a quantitative or qualitative threshold is specifically mentioned in ASC 842.   At the end, the first alternative, i.e., making no change to the standard and the definition of a lease under US GAAP was agreed upon.  If you’d like to learn more about other changes, we recommend you subscribe to our blog. We document any and all changes to ASC 842: Lease Accounting regularly to ensure our readers are always up to date!  Try iLeasePro for free right now; You can take a video tour of iLeasePro or schedule some time on our online demo calendar to see how iLeasePro can help you and your firm comply to the ASC 842 Standard.  

ASC 842 Changes: Would a Specific Incremental Borrowing Rate Be Better?

image_pen The problem of determining the rate implicit in a lease also presented a concern that most preparers used the incremental borrowing rate (IBR) as the discount rate. However, that wasn’t the only concern that came to light during FASB’s roundtable in September 2020.   Apart from the rate implicit, members also discussed the IBR; i.e., how those that have adopted ASC 842 determine the IBR. It was recognized that a lot of time and effort goes into estimating the borrowing rate.  The Problem  For Non-Public Business Entity (Non-PBE) lessees, a risk-free rate is determined which uses a period set in the lease terms (paragraph 842-20-30-3). This risk-free rate was another cause for concern at the roundtable. The use of this risk-free rate under the current economic climate meant low rates and therefore high artificial lease liabilities, thus being potentially misleading for users.   When the costs incurred to determine the IBR, and the prospect of using a risk-free rate were combined, a question arose whether non-public business entities as well as public should be allowed to use some other rate or not.  Alternatives Proposed  Based on the argument, FASB proposed two alternatives to the members, preparers, and users in the roundtable handout. 
  1. No change. The rate and method used right now to determine and use IBR for PBE and non-PBEs should remain the same.  
  1. Both PBE and non-PBE lessees must use a market-specific rate instead of IBR.  
When the two alternatives were discussed, following were the respective arguments for and against the prospects.  
  1. Non-PBE would encounter issues when trying to determine IBR that falls on the definition presented in ASC 842 for IBR. The problem they would face would primarily be that they don’t have enough resources or departments that can determine a lease credit risk. However, if nothing is done, it is important to remember that the cost of determining IBR will only go down on a go-forward basis.  
  1. The second alternative suggested that a rate be recommended like in ASC 944 (Insurance) and ASC 715 (Compensation). The use of this rate would significantly simplify the whole process, not to mention result in more uniform and comparable books. The problem here is that the rate may be very different from risk-free rates that non-PBEs use. 
The Decision  Most participants agreed that the first alternative is much better, i.e., current requirements for IBR should remain the same for public companies. Preparers agreed that creating a new process for IBR would cost even more, though they agreed that postimplementation costs would be lesser.   Since users mostly use Disclosureto compare and evaluate companies, IBR didn’t really make much of a difference there.  However, this was all limited to PBEs. When it came to non-PBEs, most members were in favor of making adjustments to the standard. The change in ASC 842, if any, would be targeted toward allowing non-PBEs to choose whether they use the risk-free rate on: 
  • An asset-class basis  
  • Or for the whole entity. 
It was acknowledged there was a certain arbitration involved by allowing non-PBEs to use risk-free rates. To that end, members mostly were in favor of letting the FASB determine a specific rate for non-PBEs and implementing it via ASC 842.   Try iLeasePro for free right now; You can take a video tour of iLeasePro or schedule some time on our online demo calendar to see how iLeasePro can help you and your firm comply to the ASC 842 Standard.

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