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paid at the inception of the lease. The entry in the Topic 842 is based on
chart “Accounting for End of Year 1” records the
first year’s lease expense (under Topic 840).
A future deductible amount arises from the determining whether
difference between the portion of fixed lease
expense related to the average lease payments of a contract conveys the
$1,160,250 and the lease payment of $1,000,000,
or $160,250. Given a marginal tax rate of 21%,
$160,250 × 0.21= $33,653. The entry in the chart right to control the use
a deferred tax asset results in the amount of

“Deferred Tax Asset and Income Tax Expense”
accounts for tax effects related to benefits associ- of an identified asset.
ated with future deductible amounts.
In a year when a lease payment exceeds lease
expense (for example, year 15 in the table
“Expense and Amortization Schedule” on page right-of-use asset over the lease term, while it
XX), the entry in the chart “Accounting for End requires the lessee to amortize the related lease
of Year 15” records lease expense for year 15. obligation using the effective interest method. In
A portion of the tax benefits from prior years’ contrast, for operating leases a single lease cost is
deferred tax assets are realized because deductions recognized.
for tax purposes of $1,217,500 exceed the income Based on comment letters received from
tax expense of $1,167,750 for financial reporting various stakeholders in the new guidance that
purposes. This realization is due to a reduction emerged, FASB provided lessees with an option
of deferred rent, the difference between the lease to apply a package of practical expedients (per
payments of $1,210,000 and the portion of the FASB ASC Paragraph 842-10-65-1) to ease the
lease expense attributable to the lease payments of transition. Paragraph 842-10-65-1, subparagraph
$1,160,250, or $49,750. The tax benefit associated f, provides the leasing parties with the following
with this amount is equal to $49,750 × 0.21 = transition guidance:
$10,448 and gives rise to the entry shown in the 1. An entity need not have to “reassess whether
chart “Tax Benefit Realized in Year 15.” This entry any expired or existing contracts” at transition
records a portion of the benefits from the deferred “are or contain leases.”
tax asset realized in year 15.

TOPIC 842 TREATMENT OF INITIAL DIRECT Accounting for end of year 15
COST AND DEFERRED RENT
Debit Credit
In contrast to previous GAAP, Topic 842 requires
operating leases greater than one year to be recog- Lease expense $1,167,750
nized on the balance sheet as right-of-use assets
and related lease obligations. There is no change in Deferred rent $49,750
substance to the treatment of capital leases under
Topic 840. Assuming the lease arrangements meet Initial direct cost $7,500
contract specifications and any one of the five cri-
teria underlying the financing lease classification, Cash $1,210,000
the lessee should recognize on the balance sheet a
right-of-use asset and at the same time recognize
a related lease liability. Tax benefit realized in year 15
Of course, complications could arise at
Debit Credit
transition if leases previously classified as operat-
ing under Topic 840 now meet the criteria of Income tax payable
financing leases under Topic 842. Under Topic or cash $10,448
842, income statement effects for operating leases
differ from those of financing leases. The latter Deferred tax asset $10,448
classification requires the lessee to amortize the

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