ASC 842 Leases: Lease Modification Transaction Explained with Journal Entries
Posted In | ASC Education | Gridlex AcademyThe ASC 842 lease accounting standard, established by the Financial Accounting Standards Board (FASB), has brought significant changes to the way businesses account for leases. One crucial aspect of ASC 842 is the treatment of lease modifications, which can be complex and require careful consideration. In this article, we will provide an overview of lease modification transactions under ASC 842 and illustrate how journal entries can be used to account for them.
Lease Modifications under ASC 842
A lease modification occurs when there is a change in the scope or consideration of a lease that was not part of the original terms and conditions. Examples of lease modifications include changes to the lease term, adjustments to the leased space, or modifications to the lease payment. Under ASC 842, lease modifications can be accounted for as either a separate contract or a modification to the existing contract, depending on whether the modification grants the lessee additional rights.
Journal Entries for Lease Modification Transactions
To illustrate the concept of lease modifications and the accounting treatment under ASC 842, let's consider a simplified example involving a lessee that has a 5-year lease for office space with annual lease payments of $50,000. After three years, the lessee agrees with the lessor to extend the lease term by two years and increase the annual lease payments to $60,000 for the remaining lease term.
1. Determine the accounting treatment for the modification
In this case, the lessee has not been granted additional rights, such as extra leased space. Therefore, the lease modification should be accounted for as a modification to the existing contract.
2. Calculate the revised lease liability and right-of-use (ROU) asset
The lessee must recalculate the lease liability and ROU asset based on the modified lease terms, using the updated discount rate at the modification date. Let's assume the present value of the remaining lease payments is $100,000, and the carrying amount of the ROU asset is $75,000 at the time of modification.
3. Journal entries for lease modification
Now, let's create journal entries to account for the lease modification:
a) Record the adjustment to the lease liability:
Debit: Lease Liability - $25,000
Credit: ROU Asset - $25,000
b) Record the increased lease payment:
Debit: Lease Expense - $10,000
Credit: Cash - $10,000
The ASC 842 lease accounting standard has introduced new requirements for lease modifications, requiring businesses to carefully consider the accounting treatment for such changes. By understanding the concepts of lease modifications and properly accounting for them through journal entries, businesses can ensure accurate lease accounting and maintain compliance with ASC 842. As businesses continue to adapt to the new lease accounting landscape, it is essential to invest in the right tools and resources, such as advanced accounting software, to streamline the process and ensure ongoing compliance.