Leases are on the Move: What You Need to be Aware of Now
(To the Statement of Financial Position / Balance Sheet)
For most non-profit organizations the implementation date for the new lease standard will be fiscal years beginning after December 15, 2019, Note that early application is permitted.
- For Calendar year end organizations, this is the year ending December 31, 2020.
- For Fiscal year end organizations, this is the fiscal year end beginning after December 15, 2019, so for example for a June 30 year-end, June 30, 2021.
Key Changes on the Horizon for Lease Accounting
The new accounting standard on leases (Accounting Standards Update (ASU) 2016-02 – Leases) is bringing changes in the way operating leases are recorded. In the past, operating leases only appeared as an expense in the financial statements. Now, it is also required to show an asset related to the right to use the leased item, and a liability for the value and obligations created by the full terms of leases.
Prior to this new lease standard, the key determination has been whether a lease was a capital lease or an operating lease. Upon implementation of this new standard, the critical determination will be whether a contract is a lease or contains a lease. This is because now we need to recognize lease assets and lease liabilities for all leases, (both financing and operating types) with the only exception being for short term leases.
Key points to be aware of now:
- When to Record – Recognition and measurement for the asset and liability is made on the lease commencement date. This is the date the underlying asset is made available for use by the lessor to the lessee.
- Consider Components – The lease payments must be separated into lease and non-lease components for the determination of the asset and liability amounts.
- Options Count – The measurement of the lease asset and liability includes payments to be made in optional periods if the lessee is reasonably certain to exercise that option, likewise for options to terminate.
- Modifications = Reassessment – The lease classification and measurements will be reassessed when modifications are made or events that were considered reasonably certain at the initial recognition date do not occur.
- Terms of 1 Year and Under – Although the standard applies to all leases, organizations may make an accounting policy election to not recognize lease assets and lease liabilities for leases with terms of 12 months or less.
- Components that are Difficult to Separate – As a practical expedient, all components (lease and non-lease) may be included as lease components. Choosing this method may increase both the right of use asset and the liability.
Be Prepared – Steps You Can Take Now:
- Identify all leases and compile a list; bear in mind that some service agreements that are not "lease agreements" may contain a lease. A lease exists if there is an identified asset in the agreement over which your organization has control. By way of example, a delivery contract that includes a truck your organization will operate, includes a lease.
- While the impact will be a net zero, prepare the Board and other readers of the organizations financial statements for the coming change.
- If your organization has debt covenants, recording the right of use asset and liability on leases may have an impact on your performance of those covenants. Pro-active communication with the lender is advisable.
If your organization is considering early adoption or you would like assistance reviewing current leases and other service agreements, planning to meet the upcoming lease standard requirements, estimating their impact on your organizations financials or debt covenants, or preparing your board or other financial statement readers for the coming changes, we can help.