Lease Considerations for Not-for-Profit Organizations

How the lease accounting standard impacts not-for-profit organizations

he lease accounting standard, ASC 842, is now in effect — which we weren’t sure we’d see, after continued delays postponed the implementation start date. While organizations have begun to implement the standard, questions still remain. This comes as no surprise, though, as implementation is a large and complicated undertaking. The lease standard under ASC 842 affects all entities that issue financial statements in accordance with GAAP. That said, the majority of our not-for-profit clients will have to comply in some way. Below, we highlight key considerations for auditors to keep in mind as they audit the implementation for their not-for-profit clients.

By Ashley Johnson,

Key take-aways of the standard are as follows:

Lease considerations: Embedded leases

Background

The FASB enacted ASC 842 to align the reporting of leases more closely across organizations and industries to increase transparency, reduce balance sheet errors, and standardize and simplify reporting.

The standard requires organizations to recognize liabilities and related assets that are or contain a lease of identified property, plant or equipment. Specifically, the standard states that a contract is or contains a lease if the contract conveys the right to control the use of an identified asset for a period of time. As not-for-profit organizations operate on limited budgets, leased property and equipment are often utilized to cut costs and remain on budget. This type of arrangement will need to be analyzed under ASC 842.

Embedded leases are arrangements that bundle a service and a device — for example, the use of information technology in a service contract. Embedded leases also apply to rented food service and facilities management — such as water coolers or food service equipment for events — that are included in a service contract. Not-for-profit organizations must account for these leases under the new standard.

Lease considerations: Below-market and contributed leases

Not-for-profit organizations often utilize contributed and below-market leases, which are leases for no cost or below-market consideration. Under ASC 842, the FASB concluded that the definition of a lease does not apply to below-market leases. The standard clarifies that the definition of a lease requires an exchange for consideration; therefore, the use of an identified asset without payment or with only a “de minimis” payment (such as a below-market lease) would not qualify. Instead, not-for-profit organizations should recognize the fair value of the below-market lease as contributed revenue and rent expense on a periodic basis.

In the case of contributed leases, the measurement of right-of-use assets at cost is consistent with guidance in ASC 842. The FASB determined that it would be less complex and costly for not-for-profit organizations to apply the new lease standards to contributed leases rather than to the fair-value measurement.

Lease considerations: When to implement

Preparing not-for-profit clients to adopt the lease accounting standards is an ongoing feat that is not slowed by implementation that has already begun. Auditors should be sure to review and discuss the following items with notfor-profit clients:

• Policy elections: ASC 842 provides several practical expedients for lessees that can have a significant impact on recorded balances. It’s important for organizations to both understand the impacts of these policy elections and document their decisions.

• Short-term lease exceptions: As an accounting policy, organizations may elect not to record “short-term” leases on the balance sheet. To qualify as a short-term lease, a lease must have an initial term of 12 months or less and not include renewal options or a purchase option that the lessee is reasonably certain to exercise. This accounting policy election is made by class of underlying asset.

• Reasonable capitalization threshold: This differs from the fixed asset capitalization threshold and must be analyzed separately.

• Risk-free rate: A lessee that is not a public business entity can elect by class of underlying asset to use a risk-free discount rate (determined using a period comparable to the lease term) as the discount rate for the lease.

• Discount rate: Lessees that are nonpublic businesses may use a risk-free discount rate that reflects a time period comparable to the lease term as an accounting policy election by class of underlying asset.