The Financial Accounting Standards Board (FASB)’s Lease Accounting Standards Update originally issued in 2016, with targeted subsequent amendments, is tentatively effective for non-profits that are not direct or conduit bond obligors for reporting periods beginning after December 15, 2019. Currently, FASB has proposed delaying these standards for non-profits that are not direct or conduit bond obligors (entities are not public business entities) for another year (effective then for calendar year 2021 and fiscal year June 30, 2022.) The intent of this update is to improve accounting and financial reporting by improving transparency and comparability among organizations by recognizing lease assets and lease liabilities.
Key Highlights:
●All leases create an asset and a liability for a lessee.
●Critical determination to be made is whether a contract contains a lease.
How is a Lease Defined?
A lease is defined as a contract that conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration.
What Types of Leases Are There with Adoption of the New Lease Standard?
The new lease standard categorizes and accounts for leases differently between finance/sales-type leases and operating leases.
Finance and sales-type leases are leases that meet one of the following criteria:
●The lease transfers ownership of the underlying asset by the end of the term.
●The lease grants an option to purchase the underlying asset, and it is reasonably certain to exercise.
●The lease term is a major part of the economic life of the underlying asset.
●The present value of the lease payments equals or exceeds the fair value of the underlying asset.
●The underlying asset is specialized, and there is no alternative use to the lessor at the end of the lease term.
Operating leases are defined as any lease agreement not meeting the criteria above.
How is the Lease Term Defined?
A lease term is defined as the period during which a lessee has a noncancelable right to use an underlying asset, plus periods covered by a lessee’s or lessor’s option to extend or terminate the lease if it is reasonably certain. Periods for which both the lessee and lessor have an option to terminate without permission from the other party (or if both have to agree to extend) are cancelable periods and are excluded from the lease term (such as rolling month-to-month leases).
When Should a Lease Term Be Reassessed?
A lease term should be reassessed if the lessee or lessor elects an option that was not previously determined to be exercised, or an event specified in the lease contract that requires an extension or termination of the lease takes place.
What Leases are Excluded from the New Lease Standard?
●Leases of intangible assets
●Leases of biological assets (timber, plants, animals)
●Leases to explore for or use minerals, oil, natural gas, etc.
●Leases of inventory
●Leases of assets under construction
How Should My Organization Handle Short Term Leases?
Organizations have the option to elect an accounting policy to exclude short term leases from the scope of the standard. The maximum term for a short-term lease is 12 months, including options to extend. Cancelable leases by either party such as month-to-month or year-to-year leases are considered short-term leases. Election needs to be consistently applied for the same types of leases.
How Should My Financial Statements Be Presented if my Organization is a Lessee?
Measurement of the Lease Liability and Lease Asset
The lease liability is measured by the present value of payments expected to be made during the lease term. The discount rate used for measurement should be the interest rate the lessor charges or the organizations incremental borrowing rate.
The lease asset is measured as the sum of the lease liability, any payments made to the lessor at or before the commencement of the lease term, and any initial direct costs to place the asset in service.
Statement of Activities and Statement of Cash Flow Treatment
Finance/Sales Type Leases:
●Recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of activities.
●Classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments in the operating activities of the statement of cash flows.
●Requirements for income statement recognition or finance (capital) leases are essentially the same as current US GAAP.
Operating Leases:
●Recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis.
●Classify all cash payments within the operating activities of the statement of cash flows.
Financial Statement Disclosure Requirements
●Basis and terms of the lease
●Existence and terms and conditions to extend or terminate
●The terms and conditions of residual value guarantees
●Restrictions and covenants imposed
●Finance lease cost – segregated between the amortization of the right-to-use asset and lease liability
●Operating lease cost
●Maturity of undiscounted lease liabilities (finance and operating separately) on an annual basis for 5 years and the total remaining after
●Reconciliation of undiscounted cash flows to lease liability recognized
●For the Statement of Financial Position, finance and operating leases should be presented separately including right to use assets and lease liabilities. (Assets and liabilities may be combined but must include a footnote to categorize them).
How Should My Financial Statements Be Presented if my Organization is a Lessor?
Operating Leases
For operating leases, lessors recognize lease revenue over the life of the lease on the straight-line basis, and the underlying lease assets should not be derecognized.
Finance/Sales Type Leases
For finance and sales type leases, the lessor will record the net investment in the lease of which is valued at the present value of the lease payments due and amortized using the effective interest method. The underlying lease asset should be derecognized, and interest income should be recognized over the life of the lease on the effective interest method on the carrying value of the net investment in the lease.
Financial Statement Disclosure Requirements
●Basis and terms of the lease
●Existence and terms and conditions to extend or terminate
●Existence and terms and conditions of options for a lessee to purchase the underlying asset
●Lease income recognized
●The maturity of undiscounted lease receivables on an annual basis for 5 years and the total remaining after
●Reconciliation of undiscounted cash flows to lease liability recognized
What Are Some Practical Tips for Implementation?
●Gather information for all outstanding leases and evaluate the terms and conditions and identify:
-Length of lease
-Interest rate to apply
-Useful life of the asset
●Compile information for disclosure:
-Roll forward of leases
-Future payments schedule
-Any other payments made/received
●Assess lease agreements:
-Are terms month-to-month or less than 12 months?
-Does the lease include cancelable terms?
-Evaluate what is material to the users of the financial statements.
-Evaluate current capitalization policies and thresholds.
●Determine impact, if any, on debt covenants.
●Practical application will likely take longer and require more resources than expected.