ASC 842-10-65-1 is the transition paragraph in the FASB lease accounting codification that tells entities how to move from ASC 840 to ASC 842. It fixes the effective dates, requires a modified retrospective approach, and offers a menu of practical expedients that let you carry forward most of the conclusions you already reached under the old standard. For most organizations the transition itself is done, but the elections made under this paragraph continue to shape how legacy leases sit on the balance sheet and how new leases interact with those older choices.
Who Adopted When
The paragraph staggered adoption by entity type. Public business entities had an effective date of fiscal years beginning after December 15, 2018, so calendar-year public companies adopted on January 1, 2019. Private companies and not-for-profit organizations that are not public business entities had fiscal years beginning after December 15, 2021, which meant a January 1, 2022 adoption date for most calendar-year private entities.
Scope at the date of initial application is broad. Any contract that meets the ASC 842 definition of a lease and is still in effect on that date falls within the transition guidance, whether the entity is the lessee or the lessor.
Choosing a Transition Method
ASC 842-10-65-1 requires a modified retrospective approach rather than a full restatement of every prior period. Within that framework, you choose between two methods for recognizing the cumulative effect of adoption.
Adjust Comparative Periods
Under the first method, you apply the new standard to each lease that existed at the beginning of the earliest comparative period presented. Those prior periods are restated under ASC 842. For leases that began before that earliest comparative period, the cumulative-effect adjustment is recorded to retained earnings as of that opening date.
Effective Date Method
The second option, introduced by ASU 2018-11, lets you apply ASC 842 only as of the beginning of the adoption year with no restatement of prior periods. The cumulative-effect adjustment goes to retained earnings as of the adoption date. Comparative periods remain under ASC 840, and you continue to provide ASC 840 disclosures for those older periods.1Deloitte Accounting Research Tool. FASB Re-Leases Targeted Improvements to ASC 842 This method became the dominant choice in practice because it avoids recasting historical financials.
Measuring Lease Assets and Liabilities at Transition
How you build the opening entries depends on the ASC 840 classification of each lease.
Operating Leases
For operating leases existing at the transition date, the lessee measures the lease liability as the present value of the remaining lease payments. The calculation uses the lessee’s incremental borrowing rate determined as of the transition date, unless the rate implicit in the lease is readily determinable or the entity elects the risk-free rate described below.
The right-of-use (ROU) asset is then built from the lease liability, adjusted for balances already sitting on the books under ASC 840:
- Add any unamortized initial direct costs (if the package of practical expedients is elected) and any prepaid rent.
- Subtract any accrued or deferred rent, unamortized lease incentives, existing impairment, and any cease-use liability recognized under ASC 420.
The net difference between the new ROU assets, the lease liabilities, and the reversal of old lease-related balances flows into retained earnings as the cumulative-effect adjustment, keeping the balance sheet in balance after initial application.
Capital Leases Becoming Finance Leases
Leases classified as capital leases under ASC 840 are reclassified as the ROU asset and lease liability at their carrying amounts on the transition date. No remeasurement is required.
The Package of Three Practical Expedients
The most consequential relief in ASC 842-10-65-1 is the package of three practical expedients in paragraph (f). They must be elected together as a single package and applied consistently to every lease, whether the entity is a lessee or a lessor.2PwC Viewpoint. Overall Transition and Practical Expedients An entity that skips the package has to individually reassess every aspect of its historical leases under ASC 842’s criteria, a far heavier undertaking.
The three components:
- No reassessment of lease identification. Prior conclusions about whether an existing contract is or contains a lease carry forward. A contract not treated as a lease under ASC 840 does not need to be re-evaluated under ASC 842’s definition.2PwC Viewpoint. Overall Transition and Practical Expedients
- No reassessment of lease classification. Existing operating leases stay operating, and existing capital leases become finance leases, without running the new classification tests.
- No reassessment of initial direct costs. Costs previously capitalized under ASC 840 remain capitalized, even though ASC 842 uses a narrower definition.
The tradeoff is that some leases might have been classified differently under ASC 842’s criteria, but the package locks in the old classification for legacy leases. For large portfolios, the time savings generally outweigh that cost.
The Hindsight Expedient
Paragraph (g) lets entities use hindsight when determining the lease term and assessing impairment of ROU assets at transition. You can factor in what actually happened with renewal, termination, and purchase options rather than relying on the original assessment made at lease commencement.2PwC Viewpoint. Overall Transition and Practical Expedients
Hindsight can be elected independently, with the package of three, with the land easement expedient, or with both. It is not an all-or-nothing pairing. It must, however, be applied consistently to all leases. One limitation: hindsight only covers contractual options that existed in the original lease. If a lease was later extended through a negotiation that added a new term rather than exercising an existing option, that is a modification handled under ASC 842’s modification guidance.
The Land Easement Expedient
Paragraph (gg), added by ASU 2018-01, addresses land easements, sometimes called rights of way. Many entities held easements under ASC 840 that were never evaluated as leases. Without this expedient, those contracts would have to be pulled and assessed against the ASC 842 lease definition, a potentially huge effort for entities with extensive real estate or infrastructure operations.3PwC Viewpoint. Leases (Topic 842) – Land Easement Practical Expedient
Electing the expedient means you do not need to evaluate whether existing or expired land easements that were not previously accounted for as leases are or contain leases under ASC 842. Easements entered into or modified after the adoption date must still be evaluated under the new standard. The election can stand on its own or combine with either or both of the other expedients.
Relief for Non-Public Entities
Private companies and not-for-profit organizations that are not public business entities get an accommodation on the discount rate that materially reduces measurement cost.
Determining a lessee’s incremental borrowing rate requires considering credit risk, the collateralized nature of the hypothetical borrowing, the lease term, and the economic environment. For private companies without public debt, that analysis is expensive. Non-public entities can instead elect to use a risk-free rate, such as a U.S. Treasury rate matching the lease term, as the discount rate. The election is made by class of underlying asset rather than at the entity level.4PwC Viewpoint. Leases (Topic 842) – Discount Rate for Lessees That Are Not Public Business Entities
The risk-free rate is lower than most entities’ borrowing rates, so the present value of lease payments, and therefore the lease liability, ends up larger than it would under the incremental borrowing rate. For operating leases, total expense over the lease term does not change, because operating lease cost is recognized on a straight-line basis regardless of the discount rate. For finance leases, timing of interest and amortization shifts but total cost over the lease life does not. One override applies: if the rate implicit in an individual lease is readily determinable, that rate must be used for that lease even if the entity has otherwise elected the risk-free rate for the asset class.
The effective date method described earlier, while available to all entities, was particularly valuable for private companies that lacked the accounting infrastructure to recast historical periods.
Lessor Transition
The expedients in ASC 842-10-65-1 apply to lessors as well as lessees. A lessor that elects the package of three must apply it consistently across all leases in which it participates in either role.
If a lessor’s lease was classified as operating under ASC 840 and remains operating under ASC 842, the lessor keeps carrying the underlying asset and any related balances such as deferred rent at the same amounts. When the package is elected, unamortized initial direct costs stay capitalized. Without the package, any costs that do not meet the narrower ASC 842 definition are written off against opening equity.5PwC Viewpoint. Lessor Transition
For leases previously classified as direct financing or sales-type, the lessor keeps recognizing its net investment at the ASC 840 carrying amount. Even without electing the package, the transition guidance does not require lessors to write off initial direct costs included in the net investment of a direct financing lease that would not qualify under the stricter ASC 842 definition.
Transition Disclosures
Adopting ASC 842 is a change in accounting principle, so the disclosure requirements of ASC 250 apply. The standard carves out two specific ASC 250 requirements that entities do not need to provide, but the remaining framework is mandatory regardless of which expedients were elected.6PwC Viewpoint. Transition Disclosure
- The nature of and reason for the change, including why the new standard is considered preferable.
- The method of transition, whether comparative periods were adjusted or the effective date method was used, and a description of any prior-period information retrospectively adjusted.
- The cumulative-effect adjustment to retained earnings or other equity components as of the beginning of the earliest period presented or the adoption date, depending on the method.
- Which ASC 842-10-65-1 expedients were elected, including the package, hindsight, and land easement elections.
- If prior periods were not restated, a statement that they were prepared under ASC 840.
The ongoing ASC 842 disclosure requirements also kick in during the adoption period, including a reconciliation showing how previously disclosed off-balance-sheet operating lease commitments under ASC 840 connect to the newly recognized lease liabilities.
Pitfalls That Still Surface
The expedients smooth over much of the work, but a few recurring problems tripped up entities during adoption and continue to surface when legacy decisions interact with current activity.
Incomplete lease inventories were the most widespread issue. Many entities discovered that contracts they had treated as pure service agreements contained embedded leases under the ASC 842 control-of-asset framework. If the package of practical expedients was elected, overlooked contracts carried forward without reassessment, but any new or modified contract must be evaluated under the new definition. Entities that never built a complete inventory during transition often find gaps when contracts come up for renewal.
Discount rate errors were another frequent stumbling block, particularly for private companies. Entities that lacked public debt sometimes used unsecured borrowing rates or generic industry benchmarks without adjusting for collateral, producing lease liabilities that were either overstated or understated.
Failing to derecognize old ASC 840 balances also caused problems. Deferred rent, prepaid rent, and lease incentive balances must be folded into the ROU asset calculation at transition rather than left as separate line items. Entities that recorded the new ROU asset and lease liability without cleaning up these legacy balances ended up double-counting.