FASB Accounting Standards Update – Leases (Topic 842)

In 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842) which significantly affects financial statement accounting for leases.  

The new lease standard defines a lease differently from existing U.S. Generally Accepted Accounting Principles (GAAP).  Under the new lease standard, a contract is, or contains, a lease if the contract gives the entity the right to control the use of the identified property, plant or equipment (an identified asset) for a period of time in exchange for consideration.  A period of time may represent a set number of days or may be described in terms of the amount of use of an identified asset such as the amount of production units a piece of equipment may produce.

The new definition focuses on the control of a specific identified asset. The ability to control the asset distinguishes a lease from a service contract. In a service contract, the control of an asset is not conveyed to the customer. Instead, a customer pays only for the services provided and the control of the asset remains with the supplier.

Because a contract can have an embedded lease component without the term “lease” ever being used in the contract, it will be important for an organization to reassess their contracts to determine whether a contract contains a lease.  For example, a contract that bundles a service and a device may include an embedded lease.

Topic 842 retains a dual model for classifying leases, but instead of operating and capital lease classifications, they are now classified as either operating or finance. The distinction between these two classifications under the new standard will determine the treatment and recognition in the statements of activities and cash flows.  Most leases, regardless of classification type, will be recorded on the statement of financial position. However, a lessee may elect, as an accounting policy, not to record leases with terms of 12 months or less on the statement of financial position. 

Topic 842 requires lessees to recognize on the statement of financial position both:

  • a right-of-use asset, representing the lessee’s right to use the leased asset over the term of the lease; and,
  • a lease liability based on the present value of the future lease payments.

Although both operating and finance leases will be recorded on the statement of financial position, the expense recognition pattern will differ for each. For an operating lease, a lessee would recognize lease expense on a straight-line basis over the term of the lease. For a finance lease, there is a front-loaded expense pattern. The lessee would recognize both interest expense on the lease liability and amortization expense on the right-of-use asset. Therefore, the lessee would generally recognize greater expense earlier in the life of the lease for a finance lease than for an operating lease.

The new standard also significantly expands the lease disclosure requirements. Lessee disclosures include:

  • Nature of the leases
  • Related party lease transactions
  • Accounting policy election regarding short-term leases
  • Finance and operating lease costs
  • Short-term and variable lease costs
  • Net gain or loss from sale-and-lease back transactions
  • Maturity analysis for lease obligations
  • Weighted-average remaining lease term
  • Weighted-average discount rate

While the FASB has delayed the implementation date of the new lease standard for nonprofits to fiscal years beginning after December 15, 2021, churches and ministries should not postpone their implementation strategy. The implementation date for nonprofits that have issued or are a conduit bond obligor for securities that are traded, listed or quoted on an exchange for an over-the-counter-market is for fiscal years beginning after December 15, 2019.

To assist nonprofits with implementing Topic 842, CapinCrouse has designed a Lease Toolkit that will help you:

  1. Understand the new standard
  2. Extract necessary information from your lease contracts
  3. Generate the related lease calculations and disclosures

This text is provided with the understanding that ECFA is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.

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