Last Updated: September 2026
Your lease just went month-to-month. Now what?
That's the question this guide answers. Specifically, whether your month-to-month lease falls within the scope of ASC 842, and if it does, how to account for it.
FASB completed its post-implementation review (PIR) of ASC 842 in late 2025. The review confirmed that lease modifications, re-measurements, and the identification of embedded leases remain the most challenging ongoing application areas. FASB has signaled that private-company simplifications may follow, but no changes to the core lease term guidance are currently proposed. For now, the standard stands as written.
A month-to-month lease is a lease that renews automatically on a monthly basis, either from commencement or after an initial fixed term expires. Under ASC 842, the label "month-to-month" doesn't determine accounting treatment. What matters is whether the arrangement meets the definition of a lease and whether the lease term creates a noncancellable obligation.
Under ASC 842, a lease is noncancellable as long as both the lessee and the lessor have the right to continue the arrangement, and terminating it would require paying more than an insignificant penalty. If either party can walk away at any time with no meaningful consequence, the contract is cancellable, and cancellable periods are excluded from the scope of ASC 842 entirely.
A month-to-month period is noncancellable in three scenarios: it is a noncancellable period, it is a cancellable period and only one party has a termination right, or it is a cancellable period and both parties have a termination right, but either party would incur more than an insignificant penalty when terminating the lease.
A lease is cancellable when both parties have a right to terminate the lease with no more than an insignificant penalty.
The lease term under ASC 842 is the noncancellable period of the lease, plus any periods for which it is reasonably certain that renewal options will be exercised, periods for which it is reasonably certain that termination options will not be exercised, and optional periods within control of the lessor. A month-to-month lease generally has a term of one month.
Beyond the noncancellable period, lessees must assess whether they are reasonably certain to continue the arrangement. The economic factors relevant to that assessment are contract-based, asset-based, market-based, and entity-based. Examples of economic factors to consider include, but are not limited to, the following:
Given the subjectivity involved in the evaluation of these economic factors, the longer the period from the commencement date of the lease to the date of exercising the option, the more difficult it would generally be to determine whether a lessee will be reasonably certain to exercise or not exercise an option to renew or terminate a lease.
How you account for a month-to-month lease under ASC 842 depends entirely on whether it's in scope or out of scope.
If the month-to-month arrangement is noncancellable and the term is longer than 12 months if the short term policy election was made, the lessee recognizes an ROU asset and lease liability at commencement. The lease term is the noncancellable period plus any periods the lessee is reasonably certain to renew.
If the arrangement is freely cancellable, it falls outside ASC 842.
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 the monthly operating lease expense. For finance leases, the lessee will record an ROU asset and lease liability and then monthly amortization and interest expenses.
Let’s say a business leases office space under a 5-year operating lease at $5,000/month with a 4% incremental borrowing rate. At the end of year 5, the lease expires and converts to month-to-month. The lease requires 60 days' written notice to terminate.
Step 1: Is there an enforceable right to continue?
Yes. The 60-day notice requirement means the business is obligated for at least two months of rent at any point in time. The month-to-month period is not freely cancellable, thus it is noncancellable and must be recorded as an extension of the original lease term.
Step 2: Is the arrangement in scope of ASC 842?
Yes. The noncancellable period is two months. The lessee must also assess whether continuation beyond two months is reasonably certain. For this example, assume the business has no immediate plans to relocate and is operationally dependent on the space. Thus, continuation for the near term is reasonably certain. Assume the lessee determines a 6-month lease term is appropriate (the 2-month noncancellable period plus 4 months of reasonably certain renewal).
Step 3: What happens to the original ROU asset and lease liability?
At the end of year 5, the original 5-year lease has fully amortized. The ROU asset and lease liability balances are both $0. The conversion to month-to-month is effectively a revision to the existing lease, measuring an updated ROU asset and lease liability based on the new lease term.
Measurement of the new lease liability:
Monthly payment: $5,000
Lease term: 6 months
Discount rate: 4%
Present value of 6 monthly payments of $5,000 at 4% discount rate
New lease liability: $29,752
New ROU asset: $29,752 (equal to lease liability at commencement, assuming no prepaid rent or initial direct costs)
Step 4: Journal entry at commencement of month-to-month period
|
Debit |
Credit |
|
|
ROU Asset |
$29,752 |
|
|
Lease Liability |
$29,752 |
Monthly operating lease expense entry (Month 1)
|
Debit |
Credit |
|
|
Operating Lease Expense |
$5,000 |
|
|
Lease Liability |
$4,917 |
|
|
ROU Asset |
$4,917 |
|
|
Cash |
$5,000 |
(The liability reduction and ROU asset amortization are equal for operating leases when payments are flat. The difference between cash paid and interest accrual is absorbed in the straight-line expense calculation.)
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If the lease had been freely cancellable, the original ROU asset and lease liability would have been derecognized at the end of year 5, and no new lease would have been recorded; instead, expense would be recorded as incurred
If the lessee has made the short-term lease policy election under ASC 842-20-25-2, and the total lease term is 12 months or less, the lessee may bypass ROU asset and lease liability recognition entirely, even if the lease is noncancellable.
When a lease converts to month-to-month, go through these five steps before working on a journal entry:
Pull the lease document. Look specifically for: required notice periods to terminate, early-termination fees, automatic renewal language, and any clauses that restrict either party's ability to exit freely.
Can both parties terminate the agreement with no more than an insignificant penalty without the other party’s permission? If yes, the arrangement is cancellable beyond that point, and once no noncancellable period remains, rent is expensed as incurred. If only one party holds the right to cancel, or neither does, the arrangement is noncancellable, and you move to Step 3.
If the lease is noncancellable, determine the total lease term: the noncancellable period plus any periods the lessee is reasonably certain to renew. If that total term is 12 months or less with no option to purchase that the lessee is reasonably certain to exercise, and the lessee has made the short-term lease policy election, the lessee may bypass ROU asset and lease liability recognition and record straight-line rent expense instead. If the election hasn't been made, the term exceeds 12 months, or a purchase option is present, proceed to Step 4.
When the lease term is 12 months or more, apply the five classification criteria under ASC 842-20. As discussed above, most in-scope month-to-month leases will be operating leases.
The short-term lease practical expedient under ASC 842 allows lessees to exclude leases with a term of 12 months or less from balance sheet recognition.
The election applies when two conditions are both true:
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ASC 842 applies to all leases that meet the definition of a lease and have a noncancellable term, with one exception. Lessees may elect not to apply ASC 842 to leases with a total term of 12 months or less (the short-term lease policy election under ASC 842-20-25-2) and that decision would have been made at the time of adopting ASC 842. The standard covers leases of all asset types: office space, equipment, vehicles, land, and more. If a contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration, it's a lease under ASC 842.
Any lease that (1) meets the definition of a lease under ASC 842-10-15-3, (2) has a noncancellable term, and (3) is not excluded by the short-term lease policy election is subject to the standard.
Leases with a total term of 12 months or less, and that do not include a purchase option the lessee is reasonably certain to exercise, do not have to be recognized on the balance sheet if the lessee has made the short-term lease policy election under ASC 842-20-25-2.
Only if both the lessee and lessor can each terminate it, without the other’s permission and with no more than an insignificant penalty. If that’s true for both sides, the lease term is limited to the current committed period (often about a month), which will typically qualify for the short-term lease exemption if the policy election was made and there’s no purchase option the lessee is reasonably certain to exercise. Rent is expensed as incurred and no ROU Asset or Lease Liability is recognized on the Balance Sheet. If only one party, usually the lessee, holds the right to terminate, the arrangement is still noncancellable and is evaluated like any other lease.
When the original lease term expires and the arrangement converts to month-to-month, the lessee must reassess if it is noncancellable. If the month-to-month period is noncancellable, a new ROU asset and lease liability are recognized based on the new lease term.
The short-term lease policy election allows lessees to bypass balance sheet recognition for leases with a total term of 12 months or less that doesn’t include a purchase option the lessee is reasonably certain to exercise. For month-to-month leases, this applies if the lessee has formally elected it for the applicable asset class and the total lease term (noncancellable period plus reasonably certain renewals) doesn't exceed 12 months, and there’s no purchase option.
