Are You Ready for the New Lease Accounting Rules?

CHARLES J. BURKE, CPA

After a COVID-19-related delay, the new accounting standard for leases takes effect for all organizations (including not-for-profit organizations) that have not yet adopted it for the calendar year 2022 (and fiscal years thereafter). The Financial Accounting Standards Board’s (FASB) Accounting Standards Update (ASU) 2016-02, Leases (Topic 842), applies to all entities (both lessees and lessors) that lease assets such as real estate, vehicles and equipment. The new rules are codified in FASB Accounting Standards Codification (ASC) 842. Here is an overview of what you need to know.

Related Read: Topic 842 Basics for Lessees

New accounting treatment

ASU 2016-02 is the first change to the accounting rules for leases in more than 30 years. Until now, the proper accounting for a lease depended on whether it was a capital lease (now known as a finance lease) or an operating lease.

Capital leases, such as a lease of a piece of equipment for most of its useful life, were reported as assets and liabilities on a not-for-profit organizations’ statement of financial position. Operating leases, such as a lease of office space for a shorter term, were recognized on a lessee’s financial statements as rent expense with required disclosures.

Under ASC 842, lessees must recognize assets and liabilities for all leases for terms of more than 12 months — whether the leases are finance or operating. You will need to report the right to use the leased asset as an asset on the statement of financial position, with the obligation to pay rent (reduced to its present value) to be reported as a liability.

The category of the lease comes into play when determining the proper way to recognize, measure and present a lessee’s expenses and cash flows. For not-for-profit organizations:

Finance Leases 
On the statement of activities, amortize leased assets that you have the right to use separately from recording interest on the lease liability. For the statement of cash flows, classify repayments of the principal portion of the lease liability in financing activities. Classify payments of interest on the lease liability and variable lease payments in operating activities on the statement of cash flows.

Operating Leases
Recognize a single total lease cost, allocating the cost across the lease term, typically on a straight-line basis. Classify cash payments made in operating activities on the statement of cash flows.

The new accounting rules also require additional disclosures about leases, including information about variable payments and options to renew or terminate. The accounting can become even more complicated with “embedded” contracts — or contracts with both lease and service or supply components (for example, a building lease that includes maintenance or security services). ASC 842 requires organizations to separate lease components from nonlease components. The portion of a contract payment that is related to nonlease components is excluded from the measurement of lease assets and liabilities unless the available practical expedient is elected.

Implications for your organization

The new standard could affect not-for-profit organizations in multiple ways. Most obviously, you will need to adjust your accounting and financial reporting processes and procedures to ensure compliance. The first step is to identify all your leases so that you can properly categorize them. You will also need processes to collect the necessary information on new leases going forward.

It is important to understand the potential effects of changes in your accounting and financial statements. For example, you should reach out to any lenders and similar stakeholders to determine if the changes might affect debt covenants or other significant metrics that influence their decisions.

The new rules could affect your future lease negotiations, too. Your previous priorities may change in light of the new reporting requirements. For instance, you might benefit from lower fixed rent and higher variable costs because you generally can exclude variable lease payments when measuring lease assets and lease liabilities.

Do not delay

With ASC 842 effective for most organizations in 2022, you need to prepare now. There are numerous expedients available to both lessees and lessors to ease the transition to the new standard. ORBA will be happy to discuss the necessary processes and procedures needed to comply with the new requirements.

Related Read: New Leases Standard – What Do Lessors Need to Know?

For more information, contact Charlie Burke at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.

Not-for-Profit News

KENNETH TORNHEIM, CPA, CFE

403(b) plan participation climbs

Participation in 403(b) retirement plans inched upward during the COVID-19 pandemic, from 76.6% in 2019 to 77.2% in 2020 — the highest level since tracking began in 2008. The bump is partly due to the spread of automatic enrollment, according to the annual 2021 403(b) Plan Survey from the Plan Sponsor Council of America (PSCA). Automatic enrollment has jumped 50% over the past five years. Of the nearly 400 not-for-profit organizations surveyed, 29% now offer it. Also, more than half of those automatically escalate the default deferral percentage over time.

While 403(b) plans traditionally only offered annuity products, more than half continue to offer annuities as an option for guaranteed income in retirement, versus 17% of 401(k) plans. The survey also found that not-for-profit organizations are taking the lead on certain types of retirement plan features. For example, 38% of not-for-profit organizations provide access to environmental, social and governance (ESG) investment options, compared to almost 3% of 401(k) plans.

What to know about the growth of impact investing

The number of affluent households — those with a net worth of $1 million or more (excluding primary residence) and/or an annual income of $200,000 — where donors participated in impact investing nearly doubled in 2020 (13%) compared with 2017 (7%). Minorities and younger individuals were the most likely to participate in impact investing to help achieve various societal benefits.

These findings come from The 2021 Bank of America Study of Philanthropy: Charitable Giving by Affluent Households. The study, released in September 2021, is the eighth in the series of biennial studies conducted by the Indiana University Lilly Family School of Philanthropy.

About 60% of the donors said this form of investing was made on top of their existing charitable giving, while 36% indicated impact investing replaces some of their charitable giving. Only 5% of these donors said impact investing was instead of other charitable giving.

How the Great Recession affected household giving

The share of American households that donated to charity in 2018 dropped below 50% for the first time since the Philanthropy Panel Study (PPS) began tracking the figure. Only 49.6% of U.S. households donated that year, down from just over 66% when the PPS launched in 2000.

The Indiana University Lilly Family School of Philanthropy’s The Giving Environment: Understanding Pre-Pandemic Trends in Charitable Giving, released in July 2021, reports that the giving rate in 2018 had fallen across most socio-demographic groups — including by age, income, race and level of education. Religious causes suffered the greatest reductions. The study notes that most of the decline in giving occurred after the Great Recession of 2008, but only about one-third of the drop in donating can be attributed to changes in income and wealth. Moreover, the trends did not reverse or even slow when the economy recovered.

For more information, contact Ken Tornheim at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.