Impact of New Lease Accounting Standards on Not-for-profit Organizations

The long-awaited accounting standard update (ASU) for leases is finally at our doorsteps. ASU 2016-02, Leases is effective for private companies and not-for-profit organizations with annual reporting periods beginning after December 15, 2021. Early implementation is permitted. The core principle of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 842: Leases is that lessees and lessors should recognize the assets and liabilities that arise from leases. 

For purposes of this article, we will focus on the impact to lessees under the new standard. 

Impact on Operating Leases

This ASU modifies the financial reporting requirements for organizations with operating leases with terms of greater than 12 months.  Under this ASU, not-for-profit organizations are required to recognize a right-of-use (ROU) lease asset and lease liability on the statement of financial position for leases classified as operating leases.  At initial measurement, the ROU asset and the lease liability are equal to the present value of the required future lease payments. The lessee recognizes a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis.  The payments are classified as operating payments on the statement of cash flows.  

Impact on Capital / Finance Leases

Those leases previously categorized as “capital leases” will now be considered “finance leases.”  Such leases will be accounted for and reported in a similar fashion to the previous requirements. The lessee will recognize a ROU asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position. The lessee will recognize interest on the lease liability separately from amortization of the ROU asset in the statement of activities. On the statement of cash flows, repayments of the principal portion of the lease liability will be reported within the financing activities section and payments of interest on the lease liability and variable lease payments will be reported within the operating activities section. 

Implementation Approach

A modified retrospective approach is required, which calls for the lessee recognizing and measuring leases at the beginning of the earliest period presented. However, there are practical expedients which allow for some exceptions. The new standard also requires entities to make additional disclosures to help financial statement users understand the amount, timing, and uncertainty of cash flows related to leases. Lessees must also report qualitative and quantitative information, including information about variable lease payments and options to renew leases.

Other Considerations

It is expected that this ASU will likely have the greatest effect on businesses with large volumes of real estate, manufacturing equipment, and vehicles. However, not-for-profit organizations will be impacted as well. Leases on buildings, as well as copier and phone system leases are common-place for not-for-profit organizations. Therefore, each organization should review and update their system of internal controls to ensure that their processes effectively identify operating leases and that their accounting policies and practices appropriately report these leases under the new reporting requirements of this ASU.

Finally, given the statement of financial position impact of this ASU, organizations should closely review and be monitoring any financial covenants of their loans and proactively work with their bankers to consider whether amendments to the covenants are appropriate and called for given the change to the financial reporting requirements. 

Summary

There are many complexities in the new lease standard. This article includes a summary of the high points of the new standard from a lessee approach; however, each organization has a unique set of circumstances to be considered. Organizations should reach out to their CPA with any questions they have regarding how this ASU may affect their organization’s financial statements.

The full ASU 2016-02 can be accessed at the FASB ASC website