by Michael A. Staton, CPA, managing director, Alerding CPA Group
As far back as 2016, the Financial Accounting Standards Board (FASB) began discussions on the implementation of new leasing standards. The new leasing recognition guidelines, which outlined requirements for recording almost all leases on entities’ financial statements, met significant pushback from accounting professionals and businesses alike.
Well, the delays are now over. We must all comply with the new FASB standard ASU 842 in 2022. The new standard, which applies to both non-profit and for-profit organizations, became effective for all fiscal years beginning after Dec. 15, 2021. This means that, if you have leases, you must record under the new guidelines effective Jan. 1, 2022. Financial statements for calendar years ending on Dec. 31, 2022 and fiscal years ending in 2023 must be presented with the new standard.
Under the old standards, nonprofits did not record operating leases on their statements of financial position. They simply recorded “lease expense” on statement of activities while making monthly payments. The new requirements were put in place to provide more clarity about organization’s leasing arrangements and cash flow requirements. Donors will now have more information on the future financial commitments that the organization has undertaken.
Leases will be classified as either a financing lease, an operating lease, or a short-term lease.
A financing lease is the same as what we previously called a “capital lease” under the old standards. The classification criteria are basically the same, as it requires the lease term to cover substantially all of the life of the asset being leased, title to pass at the end of the lease or a below market buy-out.
Consistent with current requirements, the lease will be required to be presented on the statement of financial position as “lease assets” and “lease liabilities,” and depreciation and interest will be reflected on the statement of activities.
Operating leases recognition will be significantly changed under the new standards. Instead of simply recording the expenditure on the statement of activities when a lease payment is made, the value of the asset will be recorded just like that of the financing leases. The statement of financial position will reflect the entities “right to use” the asset and the lease liability for remainder of the term. There is no requirement to restate prior years financials for the recognition of operating leases. FASB allows for the assets to be recorded prospectively.
Short term leases of less than 12 months in duration do not need to be recorded on the financial statements. However, if the lease is expected to be renewed annually then the lease should be recorded as an operating lease or financing lease.
There are additional concerns for your non-profit beyond just recording the lease itself. The new leases that you are recording will change the face of your statement of financial position. You will now have more assets, but you will also have more debt. This could cause your ratios to change and potentially make you out of compliance with your bank or financial institution. Your debt-to-net-assets ratio could not be out of compliance, and you could also have issues with your debt service coverage ratio. Please review these ratios with your lender in advance of issuing your year-end financial statements.
For more guidance, contact an Alerding CPA Group account representative to discuss these and any other issues you might have.