Update published on December 10, 2019: Effective dates have been deferred for non-public companies until annual financial reporting periods beginning after December 15, 2020 (2021 for calendar year-end companies). The article has been updated to reflect this change.
Back in 2016, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2016-02- Leases (Topic 842). While most not-for-profit organizations (NFPs) have some time before required adoption (calendar year 2021 for most non-public entities), it is not too early to begin considering the effects that the implementation of this standard will have on your organization’s accounting.
A short recap of the key changes for lessees:
- Lessees will recognize a right-of-use asset and lease liability for most leases
- Lease classification will drive expense recognition
- Enhanced disclosures are required
- Changes in terminology and definitions
A quick comparison to existing current GAAP treatment:
|Capital lease: asset and liability recorded on balance sheet||Both ‘financing’ and operating leases are recorded on balance sheet|
|Operating lease: no balance sheet impact|
|Short term leases – rentals||Similar if <12 months|
|Capital = balance sheet||Both ‘financing’ and operating leases are recorded on both the balance sheet and income statement – classification of lease determines classification of expense|
|Operating = expensed|
Capital vs. Financing Criteria:
|Current: Capital Lease||New: Financing Lease|
|Transfer of ownership||Transfer of ownership|
|Bargain purchase option||Option to purchase is reasonably certain to be exercised|
|Lease term > 75% of economic life||Lease term is ‘major’ part of economic life|
|PV of payments > 90% of fair value||PV of payments > ‘substantially all’ of fair value|
What Not-for-Profit Organizations can do now to prepare for the changes, and what they should know:
- Develop a data collection process to identify existing and future leases
- Revise internal controls over leasing activities
- Analyze existing lease agreements individually for proper treatment under new guidance.
- Evaluate the overall impact on your organization’s financial statements as it relates to those existing leases.
- Communicate with lenders and other parties with which the organization has contractual commitments to determine impact on existing or future covenants.
- Educate management and board members on the impacts of this standard change.
- Consider any future leasing commitments and the impact of the new standard on financial reporting for the organization.
Potential Banking Impacts
- Ratios impacted
- Current ratio will decline
- Debt to equity will increase
- Loan covenants and other longer term credit arrangements could be violated based upon the addition of right to use assets and lease liabilities
Additional NFP Considerations
NFPs that receive donated rent or have commitments for below-market leases should also consider the impacts of this new standard. Donated rent often means an NFP receives an unconditional promise to give the use of long-lived assets (such as a building or other facilities) for a specified number of periods in which the donor retains legal title; in this case, the lease would have no lease payments. Since this standard defines leases as contracts that convey the right to control the use of identified property for a period of time in exchange for consideration, and there is no consideration exchanged, donated rent falls outside the scope of this standard.
NFPs that receive below-market leases (where lease agreements call for lease payments below the fair rental value of the property) also need to consider the impacts of the new lease standard. When calculating the right to use assets and lease liabilities, organizations should only include the actual lease payments made (and not the excess value of the fair rental value of the property). Any additional value (essentially, donated rent) would be recorded as a contribution. That contribution should be recorded at the fair value of the use (less any actual lease payments made) in the period in which the contribution is received and expense in the period the property or facilities are used.
Contact your Blue & Co. advisor for more detailed information on the new lease standard, or for a more in-depth review of specific lease treatment at your organization.