If you`re familiar with accounting or finance, you`ve probably heard of ASC 842. This new standard was introduced by the Financial Accounting Standards Board (FASB) and became effective for public companies in December 2018. Private companies were given more time to comply, with a deadline of January 1, 2021. Simply put, ASC 842 outlines new rules for how companies must account for leases in their financial statements.
But what about ASC 842 license agreements? How do they fit into the picture? Before we dive into that, let`s first define what a license agreement is.
A license agreement is a legal contract between two parties that grants one party the right to use a product or service owned by the other party. In the context of ASC 842, license agreements refer to contracts that allow a company to use software or other intangible assets.
Under the new lease accounting standard, operating leases (which previously did not have to be recorded on a company`s balance sheet) must now be recognized as liabilities. However, there is an exception for leases of intangible assets, such as software licenses. These are classified as either operating or finance leases, depending on the terms of the agreement.
If the license agreement meets certain criteria, it may be considered an operating lease and the company can continue to expense the payments as they are made. However, if the license agreement meets other criteria, it must be classified as a finance lease and recorded on the balance sheet as a liability.
So, how can you determine whether a license agreement is an operating or finance lease under ASC 842? The key factors to consider are:
– Is the lease term greater than 12 months?
– Does the agreement transfer ownership of the asset to the lessee at the end of the lease term?
– Does the present value of the lease payments exceed a certain threshold?
If the answer to any of these questions is yes, the license agreement is likely a finance lease and must be recorded on the balance sheet.
As you can see, ASC 842 has implications not just for traditional leases, but also for license agreements. It`s important for companies to carefully review their agreements and classify them appropriately to ensure compliance with the new standard. Remember, failing to comply with ASC 842 can result in significant penalties and misrepresentation of financial statements.
In summary, ASC 842 license agreements refer to contracts that allow a company to use software or other intangible assets and must be classified as either operating or finance leases depending on certain criteria. Companies should carefully review their agreements to ensure compliance with the new lease accounting standard.