ASC 842 Lease Accounting Policy: A Simple, Defensible Playbook for Startups

Developing Your ASC 842 Lease Accounting Policy

The first time an investor or auditor asks for your ASC 842 lease accounting policy, it can feel like a surprise compliance test you did not study for. Suddenly, the simple monthly rent payment you have been booking in QuickBooks is not enough. You are facing a new US GAAP requirement that fundamentally changes how your balance sheet looks, and the request often comes right in the middle of a critical fundraising round or your first formal audit. For startups, particularly in SaaS, Biotech, or E-commerce, learning how to handle leases under ASC 842 for startups is not just an accounting exercise. It is a necessary step to present mature, auditable financials that build investor confidence. This guide provides a practical, step-by-step playbook to get it done without needing a full-time finance team.

Document your accounting policies in a single policy manual to ensure consistency and clarity.

What Is ASC 842? A Plain-English Overview

ASC 842 is the current lease accounting standard under US GAAP. Its primary purpose is to increase transparency by moving leasing obligations from the footnotes of your financial statements directly onto the balance sheet. The main goal of ASC 842 is to put all leases longer than 12 months onto the balance sheet.

Previously, under ASC 840, most common startup leases were called operating leases. These were simple to account for; you just recorded rent expense on the income statement each month. Now, ASC 842 requires you to recognize two new items on your balance sheet for these leases: a Right-of-Use (ROU) Asset, which represents your right to use the leased item, and a corresponding Lease Liability, which represents your obligation to make payments.

Step 1: How to Find Every Lease Under ASC 842 for Startups

To begin your ASC 842 compliance, you first need to identify every contract that contains a lease. The key question founders ask is, “What contracts do I actually need to look at?” The answer starts with the obvious and moves to the less apparent, hidden arrangements.

Identifying Obvious Leases

Start by gathering contracts for your most apparent leases. These typically include your office space, any co-working agreements for dedicated offices, and long-term equipment rentals like company vehicles or specialized machinery. These agreements are almost always leases and are the easiest ones to find and inventory.

Hunting for Embedded Leases

The harder part is identifying “embedded leases.” These are lease components hidden within broader service or supply agreements. A contract contains an embedded lease if it gives you the right to control the use of a specific, identified asset for a period of time. This is a critical distinction for tech and life sciences companies.

For example, a standard cloud computing service contract for generic server capacity is not a lease. However, a contract for the exclusive use of dedicated physical servers at a data center, identified by serial number, likely is. In practice, we see that hunting for embedded leases means looking for specific trigger phrases in your vendor agreements. Look for terms like:

• 'Exclusive use of the equipment'
• 'Asset is physically distinct'
• 'Right to operate the asset'
• 'Identified by serial number'
• 'Dedicated for your use'

A Biotech startup might find an embedded lease in a long-term agreement for a specific piece of lab equipment, while a Deeptech company might have one for a custom fabrication machine. Reviewing your service, supply, and master service agreements is essential for creating a complete lease inventory.

Step 2: Making Defensible Policy Decisions for ASC 842 Compliance

With your complete list of leases, the next step is to establish your accounting policies. For a startup without a CFO, the goal is not theoretical perfection but a simple, defensible framework. This is how you set things up for effective lease liability reporting without needing an advanced accounting degree.

Elect the Package of Practical Expedients

First, you should elect the “package of practical expedients.” This is an all-or-nothing election offered by the standard that simplifies adoption. It allows you to not reassess initial lease classifications or initial direct costs for leases that existed before you adopted ASC 842. For nearly every startup, taking this package is the right call as it saves significant time and effort. You simply document this election in your accounting policy manual.

Establish a Capitalization Threshold

Second, establish a capitalization threshold. A company can set a policy to expense leases with a total value under a certain amount, for example, $5,000. This is a materiality policy that prevents you from spending hours capitalizing a minor two-year printer lease. This avoids administrative headaches for low-value items and is a standard practice that auditors understand and expect to see.

Select an Appropriate Discount Rate

Third, you must select a discount rate to calculate the present value of your future lease payments. You have two main options: the incremental borrowing rate (IBR) or, for private companies, a risk-free rate. The IBR is the rate you would pay to borrow on a collateralized basis over a similar term. The reality for most startups is more pragmatic. Determining and documenting an IBR is difficult for an early-stage company with little to no borrowing history.

As a private company, you are permitted to use a risk-free rate, such as a U.S. Treasury rate, as the discount rate. This is a simple, defensible choice. You can find the U.S. Treasury rate for a term that matches your lease online directly from the Treasury's website. Using the risk-free rate is the recommended approach for almost all startups because of its simplicity and auditability.

Step 3: Calculating the Right-of-Use Asset and Lease Liability

After making your policy decisions, it is time to calculate the numbers. The main question here is, “How does this actually change my balance sheet and income statement?”

The Balance Sheet Gross-Up

The most significant change is the balance sheet “gross-up.” Under ASC 842, both your assets and liabilities will increase. The Lease Liability is the present value of your future lease payments, calculated using your chosen discount rate. The Right-of-Use (ROU) Asset is based on the liability, adjusted for any prepaid rent or initial direct costs.

Consider a SaaS startup signing a three-year office lease for $10,000 per month. The total payments are $360,000. Assuming a risk-free rate of 4%, the present value of those payments (the initial Lease Liability) would be approximately $337,000. On day one, you would record a journal entry in your QuickBooks general ledger to recognize both a Lease Liability and an ROU Asset of roughly $337,000. This immediately makes your company appear larger but also more leveraged.

Impact on the Income Statement

For operating leases, which cover most startup scenarios like office space, the impact on your Profit and Loss (P&L) statement is less dramatic. The standard requires that the total lease expense be recognized on a straight-line basis over the lease term. This is very similar to how you previously recorded simple rent expense.

However, the composition of that expense changes. The single lease expense line item is comprised of two parts: the amortization of the ROU asset (a non-cash expense) and the interest accretion on the lease liability. For one or two leases, this can be managed in a spreadsheet. For three or more leases, a dedicated software solution is often more efficient and accurate.

Step 4: Drafting the ASC 842 Footnote Disclosure for Lease Liability Reporting

Your final implementation step is preparing the required footnote disclosure for your financial statements. This is what your auditor will examine to confirm your compliance. “What do I need to write in my financial statements?” is a common and critical question.

The disclosure has both qualitative and quantitative components. The qualitative part describes your lease arrangements and the significant judgments and policy elections you made. The quantitative part provides key figures related to your lease portfolio, giving investors a clear picture of your obligations.

Here is a simple template you can adapt:

Note X: Leases

*Qualitative Disclosure:*
The Company’s operating leases consist primarily of office facilities and certain equipment. We determine if an arrangement is a lease at inception. Operating lease ROU assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. As the Company is a private entity, we have elected to use a risk-free rate to determine the present value of lease payments. We have also elected the package of practical expedients and have a policy to not recognize leases with a term of 12 months or less on the balance sheet.

*Quantitative Disclosure:*
As of December 31, 2023, the Company’s operating leases had a weighted-average remaining lease term of 3.5 years and a weighted-average discount rate of 4.2%. The assets and liabilities recognized on the balance sheet are as follows:

• Operating Lease ROU Assets: $450,000
• Operating Lease Liabilities: $465,000

This straightforward footnote disclosure provides the transparency auditors and investors need to see, demonstrating a mature approach to financial reporting.

A Simple ASC 842 Compliance Checklist

Navigating US GAAP lease requirements under ASC 842 does not have to be an overwhelming burden. For founders at SaaS, Biotech, and other tech startups, implementing the new lease standards can be managed with a pragmatic approach. The goal is to avoid surprises during an audit or fundraising diligence.

What founders find actually works is a simple, four-step playbook:

1. Find Your Leases: Go beyond office rent. Scour all service contracts for trigger phrases indicating embedded leases, especially for dedicated equipment. Create a master list of all potential leases with their key terms.
2. Make Key Policy Decisions: Keep it simple and defensible. Elect the package of practical expedients, set a reasonable capitalization threshold like $5,000, and use the U.S. Treasury risk-free rate as your discount rate. This is the most efficient path for a resource-constrained team.
3. Calculate the Impact: Understand that your balance sheet will 'gross up' with a new Right-of-Use Asset and Lease Liability. For one or two leases, a spreadsheet is sufficient to manage the calculations. Beyond that, consider lease accounting software to maintain accuracy.
4. Prepare Your Disclosure: Use a clear and concise footnote template in your financial statements. This demonstrates a high level of financial maturity and preparation to external parties like investors and auditors.

By following these steps, you can efficiently address ASC 842 compliance, ensuring your financials are audit-ready and providing the transparency that builds investor trust. See the accounting policy hub for templates and further reading.

Frequently Asked Questions

Q: How does ASC 842 affect startup metrics like EBITDA?
A: For operating leases, the single, straight-line lease expense is classified as an operating expense, so it generally does not change EBITDA. However, ASC 842 significantly increases total assets and liabilities on your balance sheet, which can impact leverage ratios and any debt covenants tied to them.

Q: Do I need to apply ASC 842 to short-term leases?
A: No, the standard provides a practical expedient for short-term leases. You can elect a policy to not recognize leases with a term of 12 months or less on the balance sheet. Instead, you can continue to recognize the lease payments as an expense on a straight-line basis over the lease term.

Q: What happens if a lease is modified or extended?
A: A lease modification, such as changing the term or payment amounts, typically requires you to remeasure the lease liability and ROU asset. This remeasurement is done using an updated discount rate as of the modification date. This complexity is a key reason many companies with multiple leases use specialized software.