As discussed in a previous blog post on February 25, 2016, the FASB issued a new standard on Leases (ASC 842) which absent early adoption (which is permitted) will take effect for nonpublic companies in 2020. This update comes after a study and deliberation period of almost ten years.
There was an original goal to align U.S. and International accounting standards on this issue but in the final result there still are some differences. This blog post will discuss the accounting for lessees as non-profit organizations generally do not lease property to others in commercial transactions except for the occasional sublease of office space.
The main difference between previous GAAP and the new standard is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. A lessee would recognize in the Statement of Financial Position a liability to make lease payments (the lease liability) and a right-of–use asset representing its right to use the underlying asset for the lease term. This will significantly change the Balance Sheet for many organizations who could now have major increases to their presented assets and liabilities. It’s essentially as if an organization purchased an asset with debt which now shows on their financial statements which was not there previously. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from previous GAAP. There continues to be a differentiation between finance leases and operating leases for lessees but again non-profits rarely enter into finance leases.
For operating leases, a lessee is required to do the following :
- Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the Statement of Financial Position.
- Recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis.
- Classify all cash payments within operating activities in the Statement of Cash Flows.
For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. Under this election, the lessee should recognize lease expense for such leases generally on a straight-line basis.
At the inception of a contract, an entity should determine whether the contract is or contains a lease. A lease is defined as a contract or part of a contract that conveys the right to control the use of identified property, plant and equipment (an identified asset) for a period of time in exchange for consideration. Control over the use of the asset means that the customer has both (1) – the right to obtain substantially all of the economic benefits from the use of the asset and (2) the right to direct the use of the asset.
Unlike prior GAAP, a key consideration was whether a lease was an operating lease or a capital lease because lease assets and liabilities were only recognized for capital leases. Going forward, the critical determination is whether the transaction is a lease or not as all leases over 12 months will reflect assets and liabilities.
There are a number of other issues addressed in the standard including determination of the lease term if extension options are in place, how lease modifications would be treated, treatment of initial direct costs, the criteria for finance leases, and other issues.
Over the next 4 years organizations will need to evaluate their leases and plan for the implementation of this standard.