Revisiting ASC 842 After Initial Recognition of Right-of-Use Assets and Lease Liabilities

When ASC 842 was first adopted, many companies felt relief once the initial recognition, accounting, and disclosures were complete. However, compliance does not end there. Companies must remain alert to identify and properly account for new leases as well as changes to existing leases. These changes may arise through formal modifications or through a reassessment of lease assumptions and judgments.

Lease Modifications

A lease modification is the most recognizable event that requires updated accounting. Modifications occur through negotiation and agreement between the lessee and lessor. The key question is whether the change creates a new lease or simply modifies the terms of the existing lease.

A modification is treated as a new lease if:

• It grants an additional right-of-use asset not included in the original lease, and
• The related payments are consistent with the standalone price of that asset.

If these conditions are not met, the modification is treated as a change in terms. In this case, both the right-of-use asset and lease liability must be remeasured, considering potential changes to:

• Discount rate
• Lease term (including renewal or termination options)
• Purchase options
• Lease classification

Lease Reassessments

Unlike formal modifications, lease reassessments are often triggered by changes in circumstances or judgments rather than negotiations. These can be harder to identify but require the same diligence.

Common triggers include:

• A decision not to renew a lease previously expected to be renewed
• Early termination of lease rights
• A change in the lessee’s creditworthiness affecting incremental borrowing rates
• Resolution of a contingency or changes in residual value guarantees

Reassessments require remeasurement of lease assets and liabilities, particularly regarding discount rates, lease terms, and classification. However, certain changes, such as residual value adjustments, may only affect measurement without altering lease term, rate, or classification.

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