Guide to ASC 842 for Nonprofits
Last Updated on June 27, 2023 by Morgan Beard
Lease accounting has undergone significant changes with the implementation of ASC 842, and it’s crucial for non-profit organizations to understand its implications. Financial Accounting Standards Board (FASB), sets forth new guidelines for lease accounting, replacing the previous standard ASC 840 in an effort to create more financial transparency.
ASC 842 for non-profits is a technical lift for in-house accounting teams and their external CPA networks. From understanding the requirements and challenges to implementing effective compliance strategies, this guide aims to equip non-profits with the knowledge and tools they need to meet ASC 842 standards and ensure accurate financial reporting in their lease arrangements.
ASC 842 Impact for Nonprofit Organizations
Compliance with ASC 842 is essential for non-profits as it enhances transparency, provides a clearer picture of lease obligations, and affects financial reporting. For example, nonprofits will gain a clearer view of lease costs, terms, and commitments. ASC 842 enables organizations to evaluate the financial impact and implications of their leasing activities more effectively.
Fiscal years beginning after December 15, 2021 mark the effective date for ASC 842 compliance. While public companies and private companies have made the transition, many nonprofit organizations are working through their transition from ASC 840 to ASC 842 for their 2022 year-end close. And with the lease accounting transition effort comes a heavy up-front lift to find all operating and finance leases, audit the lease data, prepare disclosures and, of course, establish sustainable systems and processes.
Transitioning to ASC 842 for Nonprofits
Lease Identification and Classification
Collecting, organizing, and abstracting lease data is the first step toward compliance. Cross-departmental collaboration is key in finding all leases, and working to locate any embedded leases.
From there lease identification processes will need to occur, in which you nonprofits carefully review their agreements and identify leases within their portfolio. It’s important to understand that leases are not limited to just traditional real estate spaces or equipment rentals. ASC 842 expands the definition of leases to include a wide range of arrangements, such as vehicles, property leases, IT equipment, and more.
Once you have your lease gathered and stored in an accessible location then you can begin with lease classification. A lease classification test reviews the criteria of a lease document to determine whether you have a finance lease or operating lease. These five tests will point you to the lease classification:
- Transfer of ownership
- Option to purchase
- The lease term & asset of economic life
- The present value exceeds in fair value
- Specialization of the asset
Lease Term and Commencement Date Determination
Properly determining the lease term and commencement date is crucial for nonprofit organizations transitioning to ASC 842. The lease term represents the period during which the nonprofit has the right to use an underlying asset, while the commencement date marks the point at which the non-profit gains control and starts incurring lease-related costs.
Lease Term: ASC 842 defines the lease term as the non-cancellable period for which the non-profit has the right to use the leased asset, including any options to extend or terminate the lease, if reasonably certain they will be exercised. Nonprofits must carefully evaluate lease agreements to identify the total duration of the lease, factoring in any renewal options, termination clauses, or contingent events that may affect the lease term.
Commencement Date: Determining the lease commencement date is essential as it marks the point at which the non-profit assumes control over the leased asset and becomes responsible for lease-related costs. ASC 842 specifies that the commencement date is the date when the non-profit has the right to use the asset, excluding any pre-commencement period covered by rent abatements, incentives, or construction activities.
Measurement of Lease Liabilities & ROU Assets
ASC 842 requires non-profit organizations to measure lease liabilities and right-of-use (ROU) assets accurately. These measurements play a crucial role in reflecting lease obligations and related assets on the balance sheet.
Lease Liabilities
Nonprofits are required to measure lease liabilities at the present value of lease payments over the lease term. This includes fixed payments, variable payments that depend on an index or rate, and any reasonably certain lease-related costs. Nonprofits should consider factors such as lease incentives, contingent rents, and purchase options when determining the present value of lease payments. The discount rate used for present value calculations should generally be the rate implicit in the lease, but if that is not readily determinable, the non-profit may use its incremental borrowing rate.
Right-of-use (ROU) Assets
Nonprofits also need to measure the ROU asset, which represents the right to use the underlying leased asset for the lease term. The ROU asset is initially measured at the lease liability amount, adjusted for any initial direct costs incurred by the non-profit. Subsequently, the ROU asset is depreciated over the lease term, considering factors such as lease term, renewal options, and impairment indicators, if applicable.
It is important for nonprofits to maintain diligent record-keeping and documentation to support the measurement of lease liabilities and ROU assets. This includes maintaining a detailed lease inventory, tracking lease payments and changes, and regularly reassessing lease-related assumptions, such as lease term or renewal options.
Lessee Accounting Considerations
Accounting considerations ASC 842 introduces several accounting considerations that non-profit organizations need to take into account when accounting for leases as lessees. These considerations include the recognition, measurement, and presentation of lease-related transactions and events in the financial statements.
Initial Recognition
Under ASC 842, nonprofits are required to recognize lease liabilities and corresponding right-of-use (ROU) assets on the balance sheet at the commencement date of the lease. This differs from the previous standard, ASC 840, where operating leases were typically not recognized on the balance sheet.
Subsequent Measurement
After the initial recognition, non-profit organizations need to measure lease liabilities by applying the effective interest method, which involves accreting interest expense and amortizing the principal amount over the lease term. The ROU asset is generally subject to depreciation, considering the lease term and any reassessment triggers.
Lease Expense Recognition
Nonprofits are required to recognize lease expenses in their income statements over the lease term. The lease expense includes the amortization of the ROU asset and the interest expense on the lease liability. The classification of lease expense may vary depending on the nature of the underlying leased asset and its usage.
Modifications and Remeasurements
If there are modifications to lease agreements or changes in lease terms, non-profit organizations need to reassess and adjust the lease liabilities and ROU assets accordingly. Any modifications should be accounted for prospectively, recognizing the impact of changes from the effective date of the modification.
Disclosures
ASC 842 mandates comprehensive disclosures regarding lease-related information. Non-profit organizations need to provide detailed disclosures about the nature of their lease arrangements, lease terms, significant judgments and assumptions applied, lease-related expenses, and other relevant information. These disclosures aim to enhance transparency and provide stakeholders with a clear understanding of the non-profit’s lease obligations and their financial impact.
Financial Statement Presentations
By carefully considering lessee accounting requirements under ASC 842, non-profit organizations can accurately reflect lease-related transactions and events in their financial statements. This promotes transparency, aligns with industry-wide accounting standards, and enables stakeholders to make informed decisions based on reliable and comprehensive lease accounting information.
Balance Sheet Presentation
Under ASC 842, nonprofit organizations are required to present lease liabilities and right-of-use (ROU) assets separately on the balance sheet. Lease liabilities should be categorized as a separate line item, typically under long-term liabilities. ROU assets should be presented separately, either as a component of property, plant, and equipment or as a separate line item.
Income Statement Presentation
Lease expenses recognized under ASC 842 should be presented in a manner consistent with the nature of the underlying lease. For example, if a lease relates to occupancy of a property, the corresponding lease expense may be classified as occupancy costs. Nonprofits should review their lease agreements and determine the appropriate classification for lease expenses in their income statements.
Cash Flow Statement Presentation
Nonprofit organizations are required to classify cash payments for leases within the operating activities section of the cash flow statement. Lease payments should be presented as cash outflows, reflecting the principal portion within financing activities and the interest portion within operating activities.
Disclosure Presentation
ASC 842 includes specific disclosure requirements to provide additional information about leases in the financial statements. Nonprofit organizations need to disclose qualitative and quantitative information about their lease arrangements, including lease terms, significant judgments and assumptions, future lease commitments, and other relevant details. These disclosures aim to provide stakeholders with a comprehensive understanding of lease-related obligations and their impact on financial statements.
Implementation Best Practices for Nonprofits
Implementing ASC 842 can be a complex process for nonprofits. To ensure a smooth transition and successful compliance, consider the following implementation best practices:
Start Early and Plan Ahead
ASC 842 implementation requires careful planning and coordination. Begin the process well in advance of the effective date to allow ample time for lease data collection, analysis, software implementation (if applicable), and staff training. Developing a comprehensive implementation plan will help ensure that key milestones are identified and tasks are assigned to the appropriate team members.
Establish a Cross-Functional Implementation Team
Create a dedicated cross-functional team comprising individuals from accounting, finance, legal, and operations departments. This team should have a clear understanding of ASC 842 requirements and collaborate to address challenges, facilitate data gathering, ensure accurate lease identification, and support the overall implementation process. Regular meetings and effective communication among team members will be essential.
Conduct a Thorough Lease Inventory
Develop a detailed inventory of all lease agreements within your organization. This inventory should capture lease terms, lease payments, renewal options, termination clauses, and other relevant data. Engage with various stakeholders across your organization to ensure a comprehensive and accurate lease inventory. Consider leveraging lease accounting software to streamline the inventory process and maintain a centralized repository of lease information.
Invest in Lease Accounting Software
Implementing lease accounting software can greatly streamline the transition to ASC 842 for nonprofits. A robust lease accounting solution can assist with lease data management, lease classification, calculation of lease liabilities and ROU assets, lease expense recognition, and generation of required disclosures. Choose a software provider that understands the unique needs of nonprofits, empowers management of the entire lease lifecycle and offers ongoing support and training.
Implement Robust Internal Controls
Establish strong internal controls to monitor and validate lease-related data, calculations, and financial statement disclosures. Regularly review and update controls to ensure accuracy and compliance. Document key processes and procedures to maintain consistency and accountability in lease accounting practices.
ASC 842 for Nonprofits
Overall, ASC 842’s impact on non-profit organizations is substantial, ranging from increased financial transparency and better decision-making to aligning with industry-wide accounting standards. It is crucial for nonprofits to recognize the importance of compliance with ASC 842 and proactively adapt their lease accounting practices to meet the requirements and expectations of regulators and stakeholders.
