Modified Retrospective Approach from ASC 842
A comprehensive guide to understanding and implementing the modified retrospective transition approach under ASC 842 lease accounting standards.
ASC 842 Lease Accounting
Jarred Wakefield
Managing Director, New York
Jarred leads CPCON's financial reporting and compliance practice from New York. With extensive experience in lease accounting standards, he helps organizations navigate ASC 842 implementation and ensure accurate financial reporting.
ASC 842, the lease accounting standard issued by the Financial Accounting Standards Board (FASB), fundamentally changed how organizations account for leases. One of the key decisions organizations face during implementation is choosing the transition approach. The modified retrospective approach has become the most popular choice due to its practical benefits.
What Is the Modified Retrospective Approach?
The modified retrospective approach is a transition method that allows organizations to apply ASC 842 at the beginning of the period of adoption rather than restating prior comparative periods. This approach provides practical relief while still achieving the standard's objectives.
Under this approach, organizations recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Prior periods presented in the financial statements are not restated.
Key Features of the Modified Retrospective Approach
No Restatement of Prior Periods
Organizations do not need to restate comparative periods presented in the financial statements. This significantly reduces the effort required for transition and avoids the complexity of applying the new standard to historical periods.
Cumulative-Effect Adjustment
The cumulative effect of applying ASC 842 is recognized as an adjustment to the opening balance of retained earnings (or other appropriate component of equity) at the date of initial application.
Practical Expedients Available
Organizations can elect various practical expedients to ease the transition burden. These expedients must be applied consistently to all leases.
Available Practical Expedients
- Package of three: No reassessment of whether contracts contain leases, lease classification, or initial direct costs
- Hindsight: Use hindsight in determining lease term and assessing impairment
- Land easements: Carry forward accounting for existing land easements
- Risk-free rate: Use risk-free rate as discount rate for certain leases
Implementation Steps
Step 1: Identify All Leases
Conduct a comprehensive inventory of all lease contracts across the organization. This includes real estate, equipment, vehicles, and embedded leases in service contracts.
Step 2: Gather Lease Data
Collect all relevant data for each lease, including payment terms, lease term, renewal options, purchase options, and any variable payment provisions.
Step 3: Determine Discount Rates
Establish appropriate discount rates for measuring lease liabilities. This is typically the rate implicit in the lease or, if not readily determinable, the lessee's incremental borrowing rate.
Step 4: Calculate Lease Liabilities and ROU Assets
Calculate the present value of remaining lease payments to determine the lease liability. The right-of-use (ROU) asset is generally measured at an amount equal to the lease liability, adjusted for prepaid or accrued lease payments.
Step 5: Record Transition Entries
Record the journal entries to recognize lease liabilities and ROU assets on the balance sheet, with any difference recorded as a cumulative-effect adjustment to retained earnings.
Comparison with Full Retrospective Approach
| Aspect | Modified Retrospective | Full Retrospective |
|---|---|---|
| Prior period restatement | Not required | Required |
| Implementation effort | Lower | Higher |
| Comparability | Limited (different basis) | Full comparability |
| Practical expedients | Available | Limited |
Disclosure Requirements
Organizations using the modified retrospective approach must disclose:
- The nature of and reason for the change in accounting principle
- The transition method and practical expedients elected
- The effect of the change on affected financial statement line items
- Qualitative information about the change's effects
How CPCON Can Help
CPCON provides comprehensive ASC 842 implementation support, including lease identification, data gathering, system implementation, and transition calculations. Our experienced team helps organizations navigate the complexities of lease accounting and ensure accurate financial reporting under the modified retrospective approach.
Contact us today to discuss your ASC 842 implementation needs.