A retailer signs a 10-year office lease at $50,000 per year. The CFO records nothing on day one, "we don't own it." The auditor books a $368,000 right-of-use asset and matching liability. ASC 842 put nearly every lease on the balance sheet, and the misclassification flips a clean opinion into a material restatement.
ASC 842 governs lessee accounting. The core shift from the legacy ASC 840 model: operating leases that used to live in footnotes now sit on the balance sheet alongside finance leases. The income statement treatment is what still distinguishes the two.
A contract contains a lease if it conveys the right to control the use of identified property, plant, or equipment for a period in exchange for consideration. Control means two things together: the right to obtain substantially all of the economic benefits from use, AND the right to direct how and for what purpose the asset is used.
If the supplier has substantive rights to substitute the asset (and would benefit economically from doing so), there is no identified asset, and therefore no lease.
Common mistakes
- Setting ROU equal to lease liability. ROU = liability + IDC + prepaid rent − incentives. A $400,000 liability with $20,000 broker commission and $15,000 tenant improvement allowance produces a $405,000 ROU. Trap answer: $400,000.
- Misapplying the 75% / 90% defaults. A 7-year lease on a 9-year asset is 77.8%: finance lease. The trap answer recomputes assuming the thresholds are advisory. They are defaults; on the exam, treat them as bright lines.
- Including usage-based variable rent in the liability. Percentage rent based on retail sales is variable and excluded from the liability, expensed when incurred. Capitalizing $30,000 of expected variable rent overstates the liability and ROU.
Bottom line
- Every lessee lease except short-term creates an ROU asset and a lease liability on the balance sheet
- Finance lease results when any one OWNES criterion is met. Otherwise operating
- Lease liability equals PV of future lease payments at the rate implicit (or the lessee's IBR)
- ROU asset equals lease liability plus initial direct costs plus prepaid rent minus lease incentives
Exam shortcut
The first thing to compute is classification, the rest of the answer keys to it. Run OWNES, then check 75% (term/life) and 90% (PV/FV). On exam day, a 7/10 ratio (70%) misses the 75% bar by a hair, operating, even though it feels close. Finance = Front-loaded, Operating = level. OWNES for the five criteria: Ownership, Written option, Nearly all economic life, Essentially all fair value, Specialized asset.
The full lesson (about 3,260 words, 22 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- III.F1
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