Creating Significant Potential Impact on Not-for-Profits - Lease Accounting Standards

In 2016, the Financial Accounting Standards Board (“FASB”) broadly updated its lease accounting standards in ASC 842. Initially, all entities were required to adopt these rules by 2020. However, due to the impacts of COVID, that deadline has been extended into 2022 for nonpublic entities like not-for-profits.

While this later deadline is good news, the time to get your organization in tune with these changes is now!

What Does ASC 842 Do?

The financial statement fraud in Enron and WorldCom, among others highlighted the need to stop organizations from keeping certain assets and liabilities as an off-balance sheet item. ASC 842 implements a one size fits all standard that requires companies to capitalize leases on the balance sheet, reporting them as right-of-use assets and liabilities. The new accounts will truncate the full value of the lease during the initial year and then diminish each year, throughout the duration of the lease term.

This significantly increases the burden for small businesses and not-for-profits around understanding their lease data, translating that data into the standards’ requirements, reporting the new balances; and then dealing with the after-effects of those large numbers. Some of the challenges will include violations of loan covenants, compliance with contracts, organizational dashboard ratios and respective expectations. Simultaneously, lease obligations will be under greater scrutiny, with the goal of improving transparency and the comparability of financial statements. This means that right-of-use assets and lease liabilities must be reported accurately and completely.

How Does this Affect My Organization?

Right of use assets have to be valued at the total amount of lease payments over the entire lease term and then brought to present value, and the liability should be recorded with their appropriate corresponding amounts.

It is important to review your leases as soon as possible! This may sound simple, but it can be complicated to determine what is and is not considered a lease, what type of lease it is, and what components are included in the lease for purposes of calculating the asset and liability.

In particular, several challenges you want to review are as follows:

General

• Are leases signed and are they current or expired? For an expired lease that is still occupied there may be terms that have changed which would also change your numbers.
• Have you followed up on allsecurity deposits? While assisting clients with this transition, we have occasionally found material, surprise income, in some cases significant amounts, particularly when there is a large portfolio of leases.
• Have you identified all leases? Leases are not limited to renting space - there are other transactions that fall under the purview of the lease standards that need to be included.

Technical

• Translate the details of the leases into accounting in accordance with the new standards; examples would include items such as, a purchase option, service fees and insurance.

Accounting

• Ensure internal accounting has the capabilities of calculating present value, translating the lease components into dollars and the respective appropriate debits and credits, segregating leases between finance and operating leases, cost allocations and the financial repercussions and reactions of third parties when seeing these new significant figures.

It is remarkable to note how leases can dramatically change the story that your financials tell about your organization as it aggregates the value of the full term of the lease into one large number.

As management reviews the effects on the organization it is prudent to:

• Implement internal controls surrounding the identification of the type of lease and lease components and modifications.
• Review with your accounting team the new standards to ensure they have all the necessary information to be compliant.
• Consider the change in the story being told by the financial statements and the impact on your organization’s ability to borrow and gain funding.

Achieving compliance will require new processes and controls and should be undertaken in cooperation with a trusted expert.

We advise all organizations to complete this process and proactively work through the potential loss of funding, borrowing ability and public rating prior to the initial year of implementation.

Learn more about Mazars’ Not-for-Profit practice and services here.