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Understanding Journal Entries for Lessees under ASC 842

The article details the initial journal entries under ASC 842 for lessees at transition, explaining how finance leases require recognizing the right-of-use asset (including initial lease liability, payments, direct costs, and incentives), measuring lease liabilities as the present value of lease payments with specific software considerations for payment timing, and recording monthly amortization and interest expenses, contrasting these with operating leases to clarify accounting treatment differences.

The Journal Entry Report Line-by-Line

This article explains the initial journal entries for both lease classifications—Finance and Operating—at the time of transition under ASC 842.

When generating the Journal Entry report in lease accounting software, the first month typically details the initial recognition of the Right-of-Use (ROU) Asset, the Lease Liability, and subsequent journal entries for the month. The entries for the first month of transition differ slightly from those for subsequent months and new leases.

The following examples use identical leases in terms, payments, and discount rates. The only difference is lease classification, which helps clarify the journal entries and recognition.

Finance Lease

For a Finance Lease, the initial journal entry at transition includes:

Initial Recognition of the ROU Asset

Sum of:

  • The amount of the initial measurement of the lease liability
  • Base Lease: Any lease payments at or before the 15th of the month of the Start Date
  • Any initial direct costs
  • Less: Incentives received
Initial Recognition of the Liability
  • Present value of lease payments

Software Note:

  • Payments from the 1st to the 15th of the first month of the lease are excluded from the liability (in PV calculation) but included in the ROU Asset.
  • Lease payments prior to the Start Date also appear in the month of the Start Date.
  • For transition leases: All payments are included in the liability (PV calculation). No payments can occur prior to the Start Date (i.e., Initial Application Date), and payments can't be after the End Date.
Amortization Expense
  • Straight-line amortization of the ROU Asset over the useful life or lease term.
Interest Expense
  • Monthly interest on the lease liability, calculated as the discount rate divided by 12, multiplied by the prior month's end-of-month long-term and short-term liability (less beginning-of-month payment).
Short Term and Long Term Liability Recognition & Cash Payments
  • Long Term Lease Liability: Amount of liability greater than 12 months from this point in time, plus cash payment as reduction of liability.
  • Short Term Lease Liability: Amount of liability less than 12 months from this point in time. The short-term portion is calculated and separated from the long-term liability to remain GAAP compliant.
  • Cash: Lease payment

Operating Lease

For an Operating Lease, the initial journal entry at transition includes:

Initial Recognition of the ROU Asset

Sum of:

  • The amount of the initial measurement of the lease liability
  • Base Lease: Any lease payments at or before the 15th of the month of the Start Date
  • Any initial direct costs
  • Less: Incentives received
Initial Recognition of the Liability
  • Present value of lease payments

Software Note:

  • Payments from the 1st to the 15th of the first month of the lease are excluded from the liability (in PV calculation) but included in the ROU Asset.
  • Lease payments prior to the Start Date also appear in the month of the Start Date.
  • For transition leases: All payments are included in the liability (PV calculation). No payments can occur prior to the Start Date (i.e., Initial Application Date), and payments can't be after the End Date.
Operating Lease Expense
  • Operating Lease Expense = Total lease payments divided by ROU Asset useful life or lease term. Under ASC 842, this is no longer the matching entry to the cash payment on the P&L.
  • ROU Asset reduction = Straight-line amortization of the ROU Asset cash payments over useful life or lease term minus the current liability interest expense.
  • LT Lease Liability increase = Monthly interest on the lease liability, calculated as discount rate divided by 12, multiplied by the prior month's end-of-month long-term and short-term liability (less beginning-of-month payment).
Short Term and Long Term Liability Recognition & Cash Payments
  • Long Term Lease Liability: Amount of liability more than 12 months from this point in time, plus cash payment as reduction of liability.
  • Short Term Lease Liability: Amount of liability less than 12 months from this point in time. The short-term portion is calculated and separated from the long-term liability to remain GAAP compliant.
  • Cash: Lease payment