How the New Changes to Lease Accounting Could Affect Your Nonprofit
In early 2016 a much-anticipated accounting standard was released on how to treat leases. This new accounting standard affects all organizations that lease assets such as real estate, vehicles and equipment.
Currently, the proper treatment of a lease depends on whether it’s a capital lease or an operating lease. Capital leases (for example, a lease of equipment with a $1 purchase option at the end) are reported as assets and liabilities on balance sheets. Operating leases (for instance, a lease of office space for 10 years) don’t appear on balance sheets and are recognized on financial statements only as rent expense and a disclosure item.
The FASB’s new guidance updates the proper treatment of leases in financial statements under U.S. GAAP. ASU 2016-02, Leases (Topic 842) requires you to recognize assets and liabilities for all leases with terms of more than 12 months. You’ll report the right to use the leased asset (for example, a building or piece of equipment) on the balance sheet as an asset and the obligation to pay rent, reduced to its present value, as a liability.
Your recognition, measurement and presentation of expenses and cash flows arising from a lease will continue to depend largely on whether it’s a finance lease (similar to a capital lease) or operating lease.
Most nonprofits will need to comply with the new standards on their financial statements for annual periods beginning after December 15, 2019, and for interim periods beginning a year later. Early adoption is permitted, and early preparation is encouraged.
With the effective date of the new accounting rules several years down the road, it might be tempting to delay preparation. That would be a mistake. The rules will apply to prior-year comparative information that is included in your financial statements when the rules take effect. If you typically include two years of comparative information, you’ll need to be able to present the 2018 and 2019 data in a format that complies with the new rules when you include it in your 2020 financial statements.
These accounting changes could have an adverse effect on any current and future loan financial covenants and your organization’s ability to meet these covenants. To avoid a default, you may need to address needed amendments before the new guidance is effective.
To get started:
- Perform an inventory of your leases — you can use the inventory to determine which leases require which accounting treatment.
- Determine the effects of additional lease liabilities — you may need to contact lenders and other stakeholders if the changes will affect debt covenants or other metrics they consider.
- Make appropriate changes to accounting and financial reporting processes — adjustments to your tracking of debt covenants and month end procedures might be necessary under the new requirements.
For more information, contact our Nonprofit Team today.
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