ASC 842 took effect for private companies for fiscal years beginning after December 15, 2021, so a calendar-year client that adopted on schedule has now closed four fiscal years under it. The transition is over, and ASC 842 lease accounting is now an annual deliverable on every client that signs a lease.
That work does not fall evenly across a client base. Some clients have one office lease and a copier. Others have a schedule nobody has opened since it was first built, a building rented from an entity the owner controls with nothing in writing, and a tax return that has never agreed with the books.
What ASC 842 Lease Accounting Changed, and What It Did Not
Topic 842 moved leases onto the balance sheet and left the tax return exactly where it was. Each half of that creates work every year.
Before Topic 842, under ASC Topic 840, lessees disclosed their future minimum lease payments at the balance sheet date, in the aggregate and for each of the five succeeding years, rather than recognizing them on the balance sheet. A lessee now recognizes a right-of-use asset, its right to use the leased item over the lease term, and a lease liability, its obligation to make the payments, for virtually all leases other than short-term ones. The Tax Adviser sets out that the liability equals the present value of future lease payments and the right-of-use asset is based on that liability, subject to adjustments such as initial direct costs. The income statement kept a dual model, so operating leases produce straight-line expense and finance leases produce a front-loaded pattern, and lessors still classify leases as operating, direct financing, or sales-type.
The dates arrived in three waves. Public business entities applied Topic 842 for fiscal years and interim periods beginning after December 15, 2018, public not-for-profit entities for fiscal years beginning after December 15, 2019, and every other entity for fiscal years beginning after December 15, 2021, with interim periods following a year later, according to the Journal of Accountancy.
The standard has not sat still since. Writing in the basis for conclusions to its common control amendment, the FASB noted that since Update 2016-02 it had issued seven Updates to assist stakeholders with implementation issues and two Updates deferring the effective date for private companies and certain not-for-profit organizations. The file a firm built in year one is not the file it maintains now.
Operating or Finance: The Bright Lines Are Gone
Classification decides the expense pattern, and under the current standard it is a judgment rather than a calculation.
SFAS 13 set four criteria for a capital lease, two of them bright lines: a term of at least 75% of the asset's economic life, or minimum lease payments with a present value of at least 90% of fair value. The CPA Journal's account of what followed is blunt. Lessees engineered terms and rates to stay under those thresholds, so most leases stayed off the balance sheet.
Topic 842 sets out five criteria and takes the bright lines out of two of them. Classification is tested at lease commencement, the date the lessor makes the underlying asset available to the lessee, not on the day the papers were signed. A lease is a finance lease if any one of these is met, as the same article lays out:
- Ownership transfers to the lessee by the end of the lease term. This one is rare and visible in the document.
- The lease grants a purchase option the lessee is reasonably certain to exercise. The old bargain-price test is gone, so the question is now about likelihood.
- The lease term covers the major part of the asset's remaining economic life, unless the lease starts at or near the end of that life. "Major part" is no longer a bright line.
- The present value of the lease payments plus any residual value guaranteed by the lessee equals or exceeds substantially all of the asset's fair value. "Substantially all" is not a bright line either.
- The asset is specialized enough that the lessor is expected to have no alternative use for it at the end of the term. This criterion is the new one, considered for the old standard and rejected then as too hard to define objectively.
The standard does not leave those two phrases empty. Its implementation guidance hands both figures back as one reasonable approach: 75% or more of the remaining economic life is a major part of it, and 90% or more of fair value is substantially all of it. The difference from the old test is that the standard offers the threshold rather than imposing it, so the number the firm applied is part of the conclusion and has to be written down somewhere. When the answer is a judgment, the workpaper has to carry the reasoning and not only the classification.
The Judgment Calls the FASB Itself Flagged
The FASB ran a post-implementation review of the leases standard and put the staff's findings in front of a public roundtable in September 2025. The lessee areas stakeholders named as hard are a short and specific list: identifying a lease including embedded leases, the discount rate, recognition and measurement, allocating consideration between lease and nonlease components, lease modifications, sale and leaseback transactions, and related party leases.
Four of these are worth working through for a private client base: three that come straight off the board's list, plus the short-term election, which is not on it and causes as much trouble as any of them.
Embedded Leases Hide in Service Contracts
An embedded lease is a lease sitting inside a contract nobody filed as one. A contract is or contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration, as The CPA Journal frames the test. Two conditions do the work. The asset has to be identified, explicitly or implicitly, with no substantive right for the supplier to substitute another one, and the customer has to obtain substantially all the economic benefits from using it and direct how it is used.
The same article works the tests through real agreements. A metering station built and operated for a single customer contains a lease, because the asset is implicitly specified and cannot be swapped. A waste-hauling contract does not, because any of the hauler's trailers can show up.
Stakeholders told the board that identifying all lease contracts, embedded ones included, took significant effort during implementation, when there was a project behind it. In year five there is no project, which is why the hunt belongs in the annual request list rather than in somebody's memory.
Common Control Arrangements Are the One the Board Answered
Entities are under common control when the same party controls both sides of the lease, the operating company and the entity that holds the building. Private company stakeholders told the FASB that determining the legally enforceable terms of such an arrangement is difficult and costly, that those arrangements are often unwritten or thin on detail, and that they may not say whether the lessee controls a renewal option at all. Anyone who has asked an owner for the lease on the building their other LLC owns has met this.
The Board answered with ASU 2023-01, which added a practical expedient, a relief provision that lets an eligible entity take a simpler route than the general requirement. An eligible lessee may use the written terms and conditions of a common control arrangement to determine whether a lease exists and, if it does, how to classify and account for it. The expedient is applied arrangement by arrangement. Where no written terms exist, an entity is prohibited from using it and has to evaluate the enforceable terms the long way, so the practical first step with a client is finding out whether anything was ever signed.
Eligibility is drawn by exclusion rather than by inclusion. The expedient is unavailable to public business entities, to not-for-profit conduit bond obligors, and to employee benefit plans that file or furnish financial statements with the SEC, which leaves it open to essentially every private company on a small firm's client list.
The same Update fixed a mismatch that shows up on these files constantly. Private company stakeholders reported that common control leases typically run for short terms, one year being the example in the board's own summary, while the lessee's leasehold improvements have a useful life far longer than that. Leasehold improvements associated with common control leases are now amortized over their useful life to the common control group rather than over the lease term, for as long as the lessee controls the underlying asset through a lease. When the lessee stops controlling it, the improvements are accounted for as a transfer between entities under common control through an adjustment to equity. Both changes took effect for fiscal years beginning after December 15, 2023.
The Discount Rate Is Rarely Sitting There
The discount rate sizes both numbers on the balance sheet, and most private clients do not have one to hand. A lessee uses the rate implicit in the lease when that rate is readily determinable, and otherwise its incremental borrowing rate, the rate it would pay to borrow on a collateralized basis over a similar term. The Journal of Accountancy describes getting there as a matter of obtaining credit-profile-specific indicative secured borrowing rates across a range of maturities and then judging their fit, which in practice means a request to the client's bank and a wait.
Non-public lessees have relief here. ASU 2021-09 lets a lessee that is not a public business entity elect a risk-free rate, a Treasury rate for example, by class of underlying asset rather than for the entity as a whole, and requires it to disclose which classes the election covers. The rate implicit in the lease still governs wherever it is readily determinable, election or no election.
The by-class version exists for a reason worth passing to the client. The FASB heard that some private companies avoided the all-or-nothing election because a risk-free rate is low next to their expected borrowing rate, and electing it everywhere could increase their lease liabilities and right-of-use assets.
The Short-Term Election Is an Election
A lessee may elect, by class of underlying asset, not to recognize a right-of-use asset and lease liability for short-term leases, and instead recognize the payments straight-line over the term, per The CPA Journal. A short-term lease is one that, at the commencement date, has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise, so the purchase option in the paperwork decides eligibility as much as the term does. It is an election, so it has to be made, documented, and applied consistently across the class rather than assumed lease by lease.
It also does less than it appears to on common control files. A one-year lease from the owner's other entity may well qualify, and the leasehold improvements sitting on that building are still amortized over their useful life to the common control group.
Book and Tax Still Disagree, Every Year
Topic 842 does not change how leases are treated for federal income tax purposes, as The Tax Adviser states plainly, so every difference that existed before it still exists, and working through the standard tends to surface tax positions nobody has examined in years. Four of them are return positions rather than footnotes.
Lease characterization. Tax asks whether the benefits and burdens of ownership passed, on all the facts and circumstances when the agreement was executed. A book finance lease is not automatically a sale for tax, and a book operating lease is not automatically a true lease. The analysis is separate and stays separate.
Section 467 rental agreements. The statute reaches a rental agreement for the use of tangible property where at least one rent amount allocable to a calendar year is paid after the close of the following calendar year, or where the rent increases over the term, and it does not apply where the payments and any other consideration for that use total $250,000 or less (26 U.S.C. 467(d)). Most agreements it does reach accrue rent when payments are due and payable under the agreement rather than on a straight line, which is the opposite of what the book operating lease reports.
Tenant improvement allowances. For book purposes a lessor's allowance reduces the consideration in the contract and therefore the right-of-use asset, recognized straight-line over the period that asset is amortized. For tax the treatment turns on who owns the resulting improvements under a benefits-and-burdens analysis, and a lessee following the book answer may be reporting the income and expense incorrectly or overstating taxable income.
Lease acquisition costs. Both regimes capitalize them, but the intangibles regulation's simplifying conventions treat employee compensation, overhead, and de minimis costs as amounts that do not facilitate the acquisition or creation of an intangible (26 CFR 1.263(a)-4(e)(4)), so a client capitalizing its own staff time because the books do is capitalizing more than tax requires.
What the Evidence Says About Variable Payments
Variable lease payments that do not depend on an index or a rate stay off the balance sheet, on the reasoning that future amounts cannot be estimated reliably. A 2023 working paper by three Harvard Business School researchers tested that reasoning against what companies actually filed.
Working from firms in the Russell 3000 index between 2015 and 2021, the authors found that more than 40% of firms with operating leases also reported variable-lease expenses, a figure that reached 51% in 2021, and that variable-lease expenses ran about 25% of operating-lease expenses for the average firm. They also found those expenses roughly as persistent and predictable as operating-lease expenses, and not very responsive to changes in revenue.
The measured consequences are the part a lender would care about. Book debt-to-equity rose by about 21% to 25% after adoption from recognizing operating-lease liabilities, and the authors' conservative estimate is that recognizing variable-lease liabilities as well would increase debt by 8% on average.
That is public-company evidence in a working paper, not a change to the standard. It still says something usable about a private client whose rent moves with sales or usage. The balance sheet shows less of that commitment than the lease does, and a lender reading the statements may ask about the difference before the client does.
Running It as a Repeatable Annual File
The part of the FASB's review a small firm can systematize is completeness. Leases sit in different corners of a business, the documents live with operations and legal rather than with finance, and getting every contract identified and its terms into one system took significant effort even with a project team on it.
Five habits make the annual pass survivable, and each is set up once per client rather than repeated:
- Run a completeness sweep instead of a rollforward. Ask for new and renewed contracts of every kind, not only the ones the client files under leases.
- Keep one repository, and a control that feeds it. Somebody has to put each newly signed contract into the schedule, or year two starts from a blank page.
- Write the policy elections down. The short-term election and the classes it covers, the election to treat lease and nonlease components as a single lease component, and the risk-free rate election and its classes.
- Use a portfolio approach for the small and repetitive. Similar low-dollar, high-volume agreements can be handled as a group, which the Journal of Accountancy notes saves considerable time.
- Teach the staff who read contracts to recognize an embedded lease. The person opening a new service agreement is usually not the person who knows to look for one.
The month-end close checklist is where the schedule work belongs once those habits exist, and for firms running this inside a client accounting services practice it is a recurring deliverable rather than a project.
When the Lease File Becomes a Staffing Question
Two findings in the FASB's cost work read differently from a firm's chair than from a preparer's. Stakeholders said their ability to adopt on time was held back by resource constraints, limited accounting staff among them. Many public company preparers added accounting personnel to implement the standard and expected some of that cost to continue, while public and private company preparers alike engaged outside consultants and paid higher audit fees.
That cost did not disappear when transition ended. It moved. Inside a firm the lease file splits cleanly: schedules, rollforwards, tie-outs, and disclosure tables that a trained preparer can run under review, against classification calls, common control judgments, and elections a partner has to own. The first half is usually what makes the season expensive, and it is the half that responds to capacity planning rather than to another technical training session.
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Where to Start This Week
Pull the client list and sort it once, on three questions rather than on revenue.
Which clients rent from an entity their owner controls, and is anything in writing? That answer decides whether the practical expedient is even available. Which clients have rent that moves with sales or usage? Those are the balance sheets that understate the commitment. Which clients signed or renewed service contracts this year? That is where the next embedded lease is.
Those three questions are where the judgment sits. Everything under them is schedule work, and schedule work is a capacity decision rather than a technical one.