ASC 842: The Difference Between the Lease Liability and the Right of Use Asset
Under ASC 842, the right-of-use (ROU) asset and the lease liability can be different due to several factors. Key reasons for the differences are as follows:
1. Initial direct costs: the ROU asset includes any initial direct costs incurred by the lessee that are directly attributable to obtaining the leased asset. These costs are added to the ROU asset but are not included in the lease liability.
2. Lease incentives: lease incentives, such as tenant improvement allowances or leasehold improvement reimbursements provided by the lessor, are subtracted from the ROU asset. These incentives reduce the carrying amount of the ROU asset but do not affect the lease liability.
3. Lease payments: the lease liability represents the present value of future lease payments, discounted using the appropriate discount rate. It includes the base lease payments and any reasonably certain variable lease payments. On the other hand, the ROU asset does not include variable lease payments that depend on an index or a rate, and it is recorded at the initial measurement of the lease liability, adjusted for lease incentives and initial direct costs.
4. Lease modifications: if a lease modification occurs after the commencement of the lease, it may result in changes to the lease liability and ROU asset. The adjustments to these amounts depend on factors such as the remaining lease term, revised lease payments, and the impact on the discount rate.
5. Impairment: the ROU asset may be subject to impairment testing if events or circumstances indicate that the carrying amount may not be recoverable. The lease liability, however, is not subject to impairment.
It is important to note that while the ROU asset and lease liability may differ initially, they should converge over the lease term as lease payments are made, and as the ROU asset is amortized and the lease liability is reduced.