As we flip the calendar to a new year, many nonprofits may be starting the process of preparing their annual financial statements. With that, there are significant changes in lease accounting effective for many organizations.
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842). The new guidance will require all leases to be recorded as assets and liabilities on the statement of financial position. This update requires capitalization of ”right-of-use assets” and recognition of an obligation for future lease payments for most leases currently classified as operating leases. In June 2020, the FASB issued ASU 2020-05 which deferred the effective date one year making it effective for annual reporting periods beginning after December 15, 2021.
For many organizations, it’s important to ensure these updates are accounted for in your financial statements. Does Topic 842 apply? First, you need to determine if your organization is a lessee or not.
Identifying a Lease
The primary way to determine if you have applicable leases is to evaluate if you have an identified asset with a right to control the use of that asset.
An identified asset can be classified explicitly, such as by a serial number, VIN number or address. Or it can be classified implicitly, like when a supplier or lessor can only provide one asset to satisfy a contract. An identified asset can’t be easily substituted by the supplier nor would the supplier benefit from providing an alternative asset.
The other element to determine if you have a lease is the right to control the use of an asset. A lease contract will always convey the right to control the use of a specified asset for a certain period. A lessee has control over an identified asset when both of the following are true:
- The lessee has the right to an asset’s direct use. This means that under the contract, a lessee can direct how and for what purpose the asset is used, including the right to change an asset’s purpose.
- The lessee has the right to receive substantially all economic benefits from the asset’s use through the duration of the contract.
A straightforward way to combine the two factors above is to analyze the items you know are being borrowed around you. For example, if your organization operates out of a certain floor of an office building or utilizes a printer and copier that’s not owned by your organization, then you may have leases to record under Topic 842.
What’s Included on the Statement of Financial Position (Balance Sheet)
Topic 842 requires capitalization of both finance (capital) and operating type leases. For each of these types of leases, you must record the right-of-use assets and lease liabilities. Below is an example of what an acceptable and non-acceptable balance sheet looks like.
How to Prepare
As you prepare for the adoption of the new standards, here are some important ways to prepare for Topic 842.
- Define a process to identify all your leases
- Determine key controls of recording leases, including consideration for renewal options
- Revisit current leases and upcoming renewals to understand the impact
- Organize your lease documentation and be proactive in getting your processes implemented
If you haven’t already, you may want to consider partnering with an outsourced accountant to assist you with your filing processes. Keeping up to date on changing policies and procedures can be difficult, and there are professionals out there to help you take the guesswork out of remaining compliant and fulfilling your responsibilities as a nonprofit organization.
At BerganKDV, we partner with nonprofits to assist with their accounting, tax, audit and advisory needs to ensure that they have the resources they need to stay compliant and streamline their internal process so that they can focus on making their mission a reality. Our team has years of experience working within the nonprofit community and serving on boards and committees themselves, so we understand the unique needs of maintaining an organization.
If you are curious to learn more about what BerganKDV can do for your nonprofit, contact us today and we would be happy to discuss. Let’s have a conversation!