After an initial term, or even at commencement, many leases can convert to a lease commonly called a “month-to-month lease.” Leases that do so may need to be recorded under ASC 842. How do you know if they do or not? We will answer this question along with a few other questions about ASC 842 month-to-month leases in this blog. Let’s get started!
Has your lease just up and converted to a month-to-month lease and you’re not sure what to do under the new lease guidance, ASC 842?
What are ASC 842 Month-to-Month Leases?
A month-to-month lease is a term commonly used to refer to a lease that renews automatically every month either at commencement or after an initial term. When reviewing the terms of leases under the guidance of ASC 842, it's important to understand the definition of a lease, the various components of the lease term, and to review the lease document for the enforceable right, cancellable, and non-cancellable terms. If the lessee or lessor can cancel the agreement at any time with no more than an insignificant penalty, the contract is no longer enforceable, and therefore is cancellable. Cancellable periods are not included in the scope of ASC 842.
What is the Term of a Month-to-Month Lease?
The term of a month-to-month lease relates to its non-cancellable period. For leases where the month-to-month period is cancellable, the lease does not fall within the scope of ASC 842 and therefore not recorded as a lease.
In some cases, leases begin as a 30-day cancellable lease, which means they may not ever be in the scope of the lease accounting standard. In other cases, when a longer-term lease is initially recorded under ASC 842 and the lease term goes to what is commonly known as month-to-month, the lease terms will still need to be reviewed for the enforceable right to continue the lease.
Instead of focusing on the term month-to-month lease and whether or not the lease in question qualifies as one, the lessee and lessor should focus on whether there is an enforceable right to continue the contract.
Accounting for ASC 842 Month-to-Month Leases
Under ASC 842, lessees recognize all leases on their balance sheet in the form of ROU assets and lease liabilities, with the exception of a policy election made for leases of less than 12 months. When a lessee determines at commencement that a contract fits the definition of a lease and the term is such that it requires reporting, they will record the lease in the same manner they use for the rest of their lease portfolio. If the lease does not fit the criteria of a lease as discussed above, it should not be recorded under ASC 842.
Do You Capitalize a Month-to-Month Lease?
When a lease fits the criteria that it should be reported under ASC 842, then it should be accounted for according to the lease classification. For operating leases, the lessee will record an ROU asset and lease liability and then monthly operating lease expense. For finance leases, the lessee will record an ROU asset and lease liability and then monthly amortization and interest expenses.
Lease Accounting for ASC 842 Month-to-Month Leases
Need help accounting for your ASC 842 month-to-month leases? Don’t hesitate to contact us here at LeaseCrunch for more information. Not only can we answer any questions you have, but we also offer white-glove lease accounting software that automates much of the accounting process which can lead to errors and non-compliance.
We pride ourselves on our customer service; those who use our software get our expertise and guidance as well. As our organization is full of CPAs and former Big Four accounting firm employees, we are happy to help answer any questions you might have.
So go ahead, reach out and ask away. We are here to help!
FAQS
Does ASC 842 apply to all leases?
ASC 842 applies to all leases unless the lessee makes the policy election to not apply the standard to leases of 12 months or less. ASC 842 is for leases of all types, buildings, equipment, vehicles, land, and more.
What leases are subject to ASC 842?
ASC 842 applies to all leases unless the lessee makes the policy election to not apply the standard to leases of 12 months or less. ASC 842 is for leases of all types, buildings, equipment, vehicles, land, and more.
Does ASC 842 apply to short term leases?
Under ASC 842, leases less than 12 months in length do not have to be recorded on the balance sheet if the lessee makes the policy election not to include leases of 12 months or less (ASC 842-20-25-2).
