ASC 842 is the accounting standard for lease accounting issued by the Financial Accounting Standards Board (FASB). It provides guidelines for how companies should account for leases on their financial statements. ASC 842 requires lessees to recognize most leases on their balance sheet, with a right-of-use (ROU) asset and a corresponding lease liability.
Here’s a breakdown of the key journal entries under ASC 842 for both lessees and lessors:
Lessees
1. Initial Recognition of Lease
When a lease is signed, the lessee records the right-of-use (ROU) asset and a corresponding lease liability.
Example: A company signs a 5-year lease for equipment with annual payments of $10,000. The present value of the lease payments is $40,000.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 01-01-2024 | Right-of-Use Asset | 40,000 | |
| 01-01-2024 | To Lease Liability | 40,000 |
Explanation:
- Right-of-Use Asset will debited to recognize the asset that the lessee has the right to use.
- Lease Liability will credited to reflect the obligation to make lease payments.
2. Lease Payment (Including Interest and Principal)
As the lease payments are made, the lease liability is reduced, and interest expense is recorded.
Example: The first payment of $10,000 is made on 12-31-2024, with $8,000 reducing the lease liability and $2,000 recognized as interest expense.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2024 | Lease Liability | 8,000 | |
| 12-31-2024 | Interest Expense | 2,000 | |
| 12-31-2024 | To Cash | 10,000 |
Explanation:
- Lease Liability will debited to reduce the amount owed.
- Interest Expense will debited to recognize the cost of financing the lease.
- Cash will credited to reflect the payment made.
3. Amortization of the Right-of-Use Asset
Over the lease term, the ROU asset is amortized.
Example: If the ROU asset is amortized on a straight-line basis over 5 years, the annual amortization is $8,000.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2024 | Amortization Expense | 8,000 | |
| 12-31-2024 | To Right-of-Use Asset | 8,000 |
Explanation:
- Amortization Expense will debited to recognize the cost of using the asset.
- Right-of-Use Asset will credited to reduce the asset’s carrying value.
Lessors
1. Initial Recognition of Lease (Operating Lease)
For an operating lease, the lessor continues to recognize the leased asset and records lease income as it is earned.
Example: The lessor leases equipment with annual payments of $10,000.
Journal Entry for Lease Payment:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2024 | Bank | 10,000 | |
| 12-31-2024 | To Lease Income | 10,000 |
Explanation:
- Bank will debited to record the lease payment received.
- Lease Income will credited to recognize the revenue earned from the lease.
2. Initial Recognition of Lease (Finance Lease)
For a finance lease, the lessor derecognizes the leased asset and recognizes a lease receivable.
Example: A lessor enters into a finance lease where the present value of lease payments is $40,000.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 01-01-2024 | Lease Receivable | 40,000 | |
| 01-01-2024 | To Equipment | 40,000 |
Explanation:
- Lease Receivable will debited to reflect the present value of lease payments.
- Equipment will credited to derecognize the asset.
3. Interest Income on Lease Receivable
As the lessee makes payments, the lessor recognizes interest income on the lease receivable.
Example: The lessor receives a payment of $10,000, with $2,000 recognized as interest income.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2024 | Bank | 10,000 | |
| 12-31-2024 | To Lease Receivable | 8,000 | |
| 12-31-2024 | To Interest Income | 2,000 |
Explanation:
- Bank will debited for the payment received.
- Lease Receivable will credited to reduce the outstanding receivable.
- Interest Income will credited to recognize the income earned from the lease.
These examples illustrate the key journal entries under ASC 842 for both lessees and lessors. The entries vary depending on the type of lease and whether it is classified as a finance or operating lease.