2026 CLFP Recertification

ASC 842, also known as Topic 842, is a standard issued by the Financial Accounting Standard Board (FASB) that established several updates to lease accounting. While the overall framework for lessors remains similar to ASC 840 (Topic 840), there are some important changes. Here is a summary of some of these adjustments:

Lease Classification. One of the most noticeable modifications under Topic 842 is the new terminology used to classify a lease. Under ASC 840, lessors were required to classify their leases as either capital or operating leases. Now, ASC 842 requires lessors to adjust the lease classification criteria to:

• Sales-Type Lease: A lessor’s lease that transfers ownership or meets criteria leading to profit recognition at lease commencement.
• Direct Financing Lease: A lessor’s lease where the lease payments and residual value guarantee equals or exceeds significantly the asset’s fair value, and the income is recognized over the lease term.
• Operating Lease: A lease that doesn’t meet the criteria for sales-type or direct financing leases (typically involving rental arrangements without ownership transfer) and the income is recognized over the lease term.

 However, it should be noted that at the time of adopting ASC 842, a lessor could choose to apply a package of practical expedients. This package includes the option not to reassess lease classification, and it must be consistently applied across all leases.

Another key update related to lease classification is that even if payment collection is uncertain, a lease can now be classified as a sales-type lease. However, if it is unlikely that the lease payments or any guaranteed residual value will be collected, any payments received must be recorded as a deposit, not as income, and the asset remains recorded in the books accordingly. If collectability is not probable for a lease that would otherwise be a direct financing lease, it must be classified as an operating lease. In such cases, income can only be recognized as cash is received, until it becomes probable that full payment will be collected.

Initial Direct Costs. ASC 842 narrows the definition of direct costs.  Indeed, under the new standard, only incremental costs that are directly tied to obtaining the lease contract can be treated as initial direct costs. This is stricter than the old rules. Costs, such as legal fees and internal salaries, which were previously spread out over the lease term under ASC 840, must now be recorded as expenses when incurred. For some lessors, this means showing higher expenses upfront but greater income recognition later in the lease term.

Transfer of Control Test. Under ASC 842, buyers/lessors must now check if they truly “purchased” the underlying asset using the transfer of control test from ASC 606 (Topic 606: Revenue from Contracts with Customers). If it is not determined to be a sale/purchase, the transaction is treated as a loan, and the lessor records a receivable. If it is a sale, the asset is recorded as a non-financial asset, but the price must be adjusted if it is not at fair value.

Expanded Disclosure Requirements. ASC 842 requires more robust disclosures. To comply with the new rules, lessors must expand the disclosures in their financial reports to include:

• Qualitative (descriptive) information: This includes key accounting judgments and estimates made, as well as how leases are structured (such as variable payments or options to end or extend the lease). Additionally, it describes how the lessor manages the risk of the asset losing value, including the use of residual value guarantees.
• Quantitative (numbers-based) information: This includes maturity analysis, sales-type and direct financing, interest income, income from operating leases, and variable leases.

In conclusion, while ASC 842 retains much of the lessor accounting structure from ASC 840, it introduces some notable changes. Lessors must carefully evaluate these changes to ensure compliance and accurate financial reporting.

Retrieved from: ASC 842 Lessors. Available at: https://kpmg.com/us/en/frv/reference-library/2021/asc-842-lessors.html