Attention nonprofits…are you up to speed on ASC 842 and your lease accounting reporting requirements? We have all the details here.

What is FASB ASC Topic 842?

FASB ASC Topic 842, Leases, requires lessees to recognize on the balance sheet the assets and liabilities associated with their lease contracts with terms of more than 12 months. The standard takes effect for fiscal years beginning after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022. So, implementation should be underway.

If your only lease is your office space , implementing the standard may not be difficult. It will be more challenging for organizations that lease many vehicles or have multiple offices or program locations that are leases, with potentially each with a different lease for its copier. Careful attention must be paid to the definition of a lease, as contracts for IT data management/cloud services, transportation, and even advertising might have a lease "embedded" in the deal.

How Many Leases do you Have and who Should Determine?

It is important for not-for-profit finance leaders to make sure they understand exactly how many leases they have according to FASB's new definition of a lease.

FASB defines a lease as a contract or part of a contract that conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration.

Control over the use of the identified asset means that the customer has both:

• the right to obtain substantially all of the economic benefits from the use of the asset and
• the right to direct the use of the asset.

Identify those key individuals within the organization who are making significant procurements so you can ask them about what they're purchasing and determine if more analysis needs to be done on whether a lease is there.

What are Embedded Leases?

Since prior to ASC 842 operating leases were not capitalized, embedded leases had very little impact on your overall financial statements. If a lease contained utility charges, tax pass-throughs, and other services such as administrative support it wasn’t a concern. This was all recorded as part of your occupancy costs on your statement of functional expenses or income statement. As you now have to capitalize leases under ASC 842, it becomes increasingly more important to ensure you are able to truly understand the terms of each agreement. As a result, you now need to:

• Examine all contracts to find any embedded leases within them
• Separate the lease components (for use of assets) from non-lease components (payments for the service) within the contract

The way your lease is written could significantly impact embedded leases. If your lease is a gross lease, whereby property taxes and common area costs (such as maintenance) are part of a fixed rate lease, ASC 842 provides for a practical expedient allowing these costs to be considered part of the lease, which means you don’t need to separate out these costs before calculating your asset. If your leases is a net lease and property taxes and other costs are variable and billed separately, these would be excluded from the lease and the calculation of your asset. As organization enter into collaborative agreements for space that include such items as secretarial support, supplies, fieldtrips, coverage, etc., you do have to go through the process of determining how much of the monthly payment is for the space cost and how much is for the additional services built into the agreement.

This review of contracts for possible embedded leases should involve multiple people throughout your organization. The finance team, people in IT roles, and anyone who performs procurement in the organization are among those who should examine contracts.

Check out part two where we discuss the process of choosing a discount rate and how the new standard will impact your financial statements.

Questions? Contact us.