Now that most not-for-profit organizations have implemented the new lease standard (ASC 842), it is a good time to look at some of the specifics of implementation and the changes to your reporting. As you may recall, the new lease standard includes any long-term agreements (over 12 months including any extensions) which include the right to use an asset for a period of time in exchange for consideration (usually cash). Recording the lease activity results in changes to the assets, liabilities, and expenses reported in your financial statements. Let’s look at the impact in each area.
Impact of New Lease Standard on Assets
Recording the present value of a stream of lease payments results in a right of use (ROU) asset and may be recorded as an operating ROU asset (typically a building or office space lease) or a finance ROU asset (typically equipment or vehicles which may have a bargain purchase at the conclusion of the lease). These ROU assets are recorded as a separate line item on the statement of financial position; usually in the other assets area, and finance lease ROU assets cannot be combined with operating lease ROU assets. The finance ROU asset is amortized (think depreciated) over the life of the lease. Operating leases ROU assets are written off as rent expense. The balance of the ROU asset under both types of leases will be zero at the end of the lease term.
Recording Lease Payments: The Impact on Liabilities
The offset to the ROU asset is to record a lease liability. Like the recording of the ROU asset, the lease liability for a finance lease is a separate line item, as is the operating lease liability. To complicate matters a little, if you present a classified statement of financial position, you will have a current portion and a long-term portion of each of these liabilities. The write-down of these liabilities occurs as you make your cash payments each period. As with the ROU asset, the liability under both types of leases will be zero after the last payment is made.
Operating Lease vs Finance Lease: Impact on Statement of Activities
As mentioned earlier, there are different expense accounts that are impacted when recording the annual activity for operating leases and finance leases. Operating lease expense shows up as lease (occupancy/rent) expense and can be included with non-lease operating expenses (a separate line-item disclosure is not required). When recording the expense for a finance lease there will be two expenses that are affected. Since with a finance lease the organization is essentially buying the asset, there will be two components of finance lease expense: amortization and interest. Like operating leases, both items can be combined with non-lease line items. Amortization would be included with depreciation and interest would be included with other interest expense (a separate line-item disclosure is not required). If lease payments increase over the term of the lease, the reduction in the ROU asset compared to the reduction in the lease liability will not be the same every year and consequently, the impact on expenses will also vary.
Understanding the Broader Implications of ASC 842
As you move forward you might consider updating internal policies and procedures regarding leases. This could include having a procedure to identify lease contracts and the specifics on handling leases (similar to how you currently process fixed asset activity), defining who has the authority to enter into a lease contract on behalf of the organization, etc.
The new standard is complex, and this article only covers some of the basics regarding leases under ASC 842. Please contact your local Hawkins Ash representative if you have questions or want assistance in understanding the impact of the new lease standard on your financial statements and on your organization.