If you’ve been managing leases as a lessee for a while, you might remember ASC 840, the old lease accounting standard that kept certain leases off the balance sheet. That approach made it hard to get a full picture of an organization’s financial obligations, often leaving stakeholders, auditors, and even accounting teams working with incomplete data.
The Financial Accounting Standards Board (FASB) introduced ASC 842 to bring greater transparency and consistency to financial reporting.
Now, any lease longer than 12 months must be recorded as both an asset and a liability on the balance sheet. No more hidden lease obligations, everything is front and center.
For nonprofit, higher education, and healthcare teams, this shift means clearer financial reporting, better decision-making, and more accountability.
However, it also comes with added complexity, especially when it comes to ASC 842 journal entries. That’s why understanding how to properly record leases under ASC 842 is critical.
Understanding Lessee Lease Classifications Under ASC 842: Operating Lease vs. Finance Lease
Not all leases are the same, at least, not under ASC 842. When recording leases, the first step is determining whether it falls into one of two categories: finance lease or operating lease.
Operating Lease vs. Finance Lease: What’s the Difference?
The distinction comes down to whether the lease is more like a purchase or a rental agreement.
- Operating leases function more like rentals. The lessee uses the asset but does not take ownership.
- Finance leases are treated more like asset purchases. If the lease transfers ownership, includes a purchase option that the lessee is reasonably certain to execute, has total payments which comprise substantially all of the underlying asset’s fair value, or has a lease term covering a majority of the asset’s useful life, it’s classified as a finance lease.
Why Lease Classification Matters
The classification determines how the lease is recorded on financial statements:
- Finance leases recognize depreciation and interest expense, meaning higher costs upfront.
- Operating leases spread lease expenses evenly over time, creating a more predictable expense pattern.
ASC 842 Journal Entries for Operating Leases
Once a lease is classified as operating, the next step is properly recording it under ASC 842. This involves two key stages: initial recognition and subsequent recognition.
1. Initial Recognition: Recording the Lease at the Start
At lease commencement, two things happen:
- A Right-of-Use (ROU) Asset is recorded on the balance sheet, representing the lessee’s right to use the asset.
- A Lease Liability is recorded, representing the obligation to make future lease payments.
Example Journal Entry for Initial Recognition
An organization signs a 4-year lease starting January 1, 2025. The lease requires $8,500 monthly payments, with a 3% annual increase and a discount rate of 4.5%. The total lease payments over the lease term will be $426,979.20.
Using the present value of future lease payments, the initial lease liability is calculated as $380,245.00.
| Month/Year | GL Description | Debit | Credit |
| 01/2025 | ROU Asset | 380,245.00 | |
| 01/2025 | Lease Liability | 380,245.00 | |
| 01/2025 | Lease Liability | 8,500.00 | |
| 01/2025 | Cash (Initial Payment) | 8,500.00 |
The ROU asset includes the lease liability plus any prepaid lease payments and initial direct costs.
The Lease Liability is the present value of all future lease payments.
The Cash entry records the first month’s payment made at lease commencement.
2. Subsequent Recognition: Monthly Lease Expense Adjustments
Unlike finance leases, operating lease expenses under ASC 842 are recognized on a straight-line basis over the lease term. This means the expense is the same every month, even though actual cash payments may vary.
Each month, the organization records:
- A lease expense (or ‘lease cost’) that spreads evenly over the lease term.
- A reduction in the ROU asset and lease liability as time passes.
Example Journal Entry for Monthly Expense Recognition
For the above lease example, the monthly straight-line lease expense is $8,895.40.
First Monthly Recognition Entry – February 2025:
| Month/Year | GL Description | Debit | Credit |
| 01/2025 | Lease Cost | 8,895.40 | |
| 01/2025 | ROU Asset | 7,115.40 | |
| 01/2025 | Lease Liability | 1,780.00 | |
| 01/2025 | Lease Liability | 890.00 | |
| 01/2025 | Lease Liability - Short Term | 890.00 |
- Operating Lease Expense (or ‘Lease Cost): Recognized on a straight-line basis throughout the lease term.
- ROU Asset Amortization: Reduction in the asset over time.
- Lease Liability Adjustment: Reflects a reduction in the present value of remaining lease obligations.
Over time, the ROU asset and lease liability continue to decrease until the lease term ends.
ASC 842 Journal Entries for Finance Leases
If a lease is classified as a finance lease under ASC 842, it’s treated more like an asset purchase than a rental. This means that, instead of a straight-line lease expense, the lessee records both interest expense and amortization expense over the lease term.
1. Initial Recognition: Recording the Lease at the Start
At lease commencement, like with an operating lease, the lessee records the ROU asset and the lease liability.
Example Journal Entry for Initial Recognition
An organization signs a 5-year lease starting January 1, 2025. The lease requires $12,000 monthly payments, with a 5% annual increase and a discount rate of 5.2%. The total lease payments over the lease term amount to $829,248.00.
Using the present value of future lease payments, the initial lease liability is calculated as $720,000.00.
| Month/Year | GL Description | Debit | Credit |
| 01/2025 | ROU Asset | 720,000 | |
| 01/2025 | Lease Liability | 720,000 | |
| 01/2025 | Lease Liability | 12,000.00 | |
| 01/2025 | Cash (Initial Payment) | 12,000.00 |
- The ROU asset includes the lease liability plus any prepaid lease payments and direct costs.
- The Lease Liability represents the present value of all future lease payments.
- The Cash entry reflects the first payment made at lease commencement, which is not included in the lease liability since it's not a future obligation.
2. Subsequent Recognition: Recording Monthly Lease Expenses
Unlike operating leases, finance leases break out costs into two separate expenses:
- Interest expense on the lease liability.
- Amortization expense to gradually reduce the ROU asset.
Example Journal Entry for Monthly Expense Recognition
| Month/Year | GL Description | Debit | Credit |
| 01/2025 | Interest Expense | 3,120.00 | |
| 01/2025 | Lease Liability | 3,120.00 | |
| 01/2025 | Amortization Expense | 12,250.00 | |
| 01/2025 | Accumulated Amortization | 12,250.00 | |
| 01/2025 | Lease Liability | 5,600.00 | |
| 01/2025 | Lease Liability - Short Term | 5,600.00 |
- Interest Expense: The cost of financing the lease liability, calculated based on the discount rate applied to the remaining lease balance.
- Amortization Expense: Straight-line reduction of the ROU asset over the lease term.
- Lease Liability Reduction: The portion of the monthly lease payment that applies to the outstanding lease liability.
- Accumulated Amortization: A contra-asset account that offsets the ROU asset balance over time.
As the lease liability is reduced, the interest expense decreases. The amortization expense, however, remains consistent each month.
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Special Journal Entries Under ASC 842
While most leases follow standard journal entry procedures, certain lease transactions require special treatment under ASC 842.
Accounting for Lease Incentives
What are Lease Incentives?
Lease incentives are benefits provided by a lessor to encourage a lessee to sign a lease. These can include:
- Cash payments or reimbursements to the lessee.
- Covering moving or improvement costs.
- Discounted or free rent for a certain period.
Under ASC 842, lease incentives reduce the initial value of the ROU asset, rather than being recognized as income.
Journal Entry for Lease Incentives Received at Lease Commencement
If a lessee receives a $10,000 incentive at the beginning of the lease, the initial journal entry would be:
Debit: ROU Asset – $90,000 (original lease value minus incentive)
Credit: Lease Liability – $100,000 (full lease obligation)
Debit: Cash – $10,000 (incentive received from lessor)
This ensures that the incentive reduces the ROU asset rather than being recognized as income.
Journal Entry for Lease Incentives Received After Lease Commencement
If the incentive is received later in the lease term, it’s recorded as a negative lease payment:
Debit: Lease Liability – $10,000 (reducing the lease obligation)
Credit: Cash – $10,000 (incentive received from lessor)
This approach ensures that the lease liability reflects only the actual payments due over the lease term.
Lease incentives can provide significant financial relief, especially for organizations managing tight budgets.
Simplify ASC 842 Journal Entries with DebtBook
Manual journal entry processes, with their reliance on spreadsheets and time-consuming calculations, only add to the burden of ASC 842 journal entries.
For many nonprofit, higher education, and healthcare teams, journal entries aren’t just a routine task; they’re a significant source of inefficiency and risk. When year-end audits come around, accounting teams often scramble to ensure accuracy while fielding auditor requests for detailed documentation.
But what if journal entries weren’t a time-consuming, error-prone process?
DebtBook’s Journal Entry Exports: Save Time, Reduce Risk, and Improve Accuracy
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- Generate detailed, audit-ready journal entries in just a few clicks, eliminating hours of manual data entry.
- Reduce the risk of financial misstatements by automating calculations and ensuring accuracy.
- Simplify compliance with ASC 842 (and GASB 87) eliminating the need for spreadsheets.
- Ensure consistency across financial reporting with built-in general ledger coding and allocation tracking.
Instead of spending valuable time compiling journal entries, DebtBook automates the entire process, allowing accounting teams to focus on reviewing and analyzing financial data rather than manually entering it.
See how DebtBook can transform your lease accounting process.
Related Lease & Subscription Management Reading
- Challenges in ASC 842 Compliance & How Technology Can Help
- Understanding ASC 842 Compliance for Nonprofits, Higher Education & Healthcare
- Automated Lease & Subscription Accounting Journal Entries: Audit-Ready in Clicks
Disclaimer: DebtBook does not provide professional services or advice. DebtBook has prepared these materials for general informational and educational purposes, which means we have not tailored the information to your specific circumstances. Please consult your professional advisors before taking action based on any information in these materials. Any use of this information is solely at your own risk.
