Why the Lease Accounting Standard was Replaced
ASC 840 is the previous lease accounting standard governing companies that file under US Generally Accepted Accounting Principles (US GAAP). ASC 842 replaced ASC 840 for public companies starting on January 1, 2019. Private companies will follow starting January 1, 2020.
Why ASC 840 was Replaced
The Off-Balance Sheet Loophole
ASC 840 classified leases as either capital or operating leases. Capital leases were capitalized on the balance sheet and reported on the income statement as an interest and depreciation expense. However, operating leases were reported in the footnotes of financial statements, rather than capitalized on the balance sheet.
After the accounting scandals of the early 2000s, the Securities and Exchange Commission (SEC) believed that this method of reporting operating leases decreased transparency into the true financial position of companies, making it difficult for small investors with limited resources to accurately value companies.
To close the loophole, the SEC directed The Financial Accounting Standards Board (FASB) to develop a new lease accounting standard. The new standard, ASC 842, still classifies leases into two groups: operating leases and finance leases. Finance leases are substantially the same as capital leases under ASC 840. However, companies must report all leases longer than 12 months in length on the balance sheet. The income statement accounting treatment for the two types of leases does not substantially change from ASC 840.
Leases were classified as either operating or capital under ASC 840. ASC 842 maintains the dual classification model, but uses slightly different criteria for classifying assets. Use the Lease Classification Tool to see how your assets are classified under ASC 842.