Lease Accounting Under ASC 842 for Construction: Right-of-Use Assets and Equipment Lease Treatment

ASC 842 (Leases) governs lease accounting under US GAAP, replacing ASC 840. Substantial change — substantially all leases now recorded on balance sheet as right-of-use (ROU) assets and lease liabilities. Operating leases previously off-balance-sheet now recorded. Construction firms with substantial equipment leases substantially affected. Finance leases similar to capital leases under prior guidance. Substantial impact on construction balance sheets. Effective for public companies 2019, private 2022. Understanding ASC 842 helps construction CFOs comply.

This post covers ASC 842 lease accounting for construction.

Lease Identification

Lease identification first step:

Lease identification first step. Right to control identified asset for period of time. In exchange for consideration. Embedded leases in service contracts — service contracts that include identified asset with control may be partial leases. Specific to facts and circumstances. Service contracts may contain leases (e.g., equipment with operator). Substantial analysis sometimes required to identify leases vs services.

Operating vs Finance Leases

Two lease classifications:

Two lease classifications. Operating leases (most leases) for use of asset without ownership. Finance leases ownership-like (replaced capital leases). Five criteria for finance — if any met, finance: title transfers, bargain purchase option, lease term covers majority of useful life, present value of payments equals or exceeds substantially all fair value, specialized asset with no alternative use to lessor. Different income statement treatment — operating expenses straight-line, finance amortization plus interest. Both recorded on balance sheet.

Right-of-Use Asset

ROU asset recognition:

ROU asset recognition. Recorded at lease commencement. Initial liability plus prepaid lease payments plus initial direct costs less lease incentives. Amortization over lease term — operating lease typically straight-line, finance accelerated. Specific to lease classification. Impairment evaluation if circumstances suggest carrying value not recoverable.

Lease Liability

Lease liability mirrors obligation:

Lease liability mirrors lease obligation. Present value of remaining lease payments at commencement. Discount rate using rate implicit in lease (rare to know) or incremental borrowing rate (typical). Updated for modifications during lease term. Reduced by payments over time. Reassessed on changes (lease term, contingent payments). Long-term and current portions classified.

Construction Equipment Leases

Equipment leases substantial:

Construction equipment leases substantial. Cranes, excavators, lifts on long-term leases. Office trailers for project duration. Vehicles in fleet. Specific equipment per project. Substantial balance sheet impact when recorded. Tracking systems important across many leases. Specific contract review for lease vs service distinction. Short-term lease exemption (12 months or less) reduces some impact.

Short-Term Lease Exemption

Short-term exemption simplifies:

Short-term lease exemption simplifies accounting. 12 months or less lease term qualifies. No purchase option that lessee reasonably certain to exercise. Election by asset class consistent. Expense as incurred without ROU and liability recording. Substantial simplification for short-term equipment rentals. Many construction equipment leases short-term — substantial benefit. Specific analysis per lease.

Disclosures

ASC 842 disclosures substantial:

ASC 842 disclosures substantial in financial statements. Lease costs by type (operating, finance). Maturities of lease liabilities by year. Weighted-average remaining term. Weighted-average discount rate. Other lease information. Substantial vs prior guidance — ASC 842 disclosures more comprehensive.

Bottom Line

ASC 842 governs lease accounting under US GAAP requiring substantially all leases on balance sheet as right-of-use assets and lease liabilities. Lease identification first step. Operating vs finance leases classification. Right-of-use asset recorded at commencement. Lease liability mirrors obligation. Construction equipment leases substantial impact. Short-term lease exemption simplifies. Disclosures substantial. For construction CFOs, ASC 842 compliance is mandatory GAAP requirement. Quality lease tracking systems support efficient compliance. Mistakes affect financial statements substantially. Worth attention from construction firms with substantial equipment lease portfolios.