Starting in 2016, the Financial Accounting Standards Board (FASB) began releasing new “lease rules.” After several “exposure drafts” and much discussion, we now have Topic 842, Leases. These new rules will mean a huge change in accounting for leased assets and the associated liabilities.
Generally, for “our size” institutions, these new standards will be required to be implemented for fiscal years beginning after December 15, 2021. This means that – for schools with a June 30 year-end – your June 30, 2023 audit report will be the first affected. For institutions on a calendar year, it will be December 31, 2022. All this means that you are already – or soon will be – under the new rules.
As an overview of the new standards, let’s take a look at some “key concepts.” We will break several of these down further in upcoming installments of “Finance Lab.”
Leases (defined): “A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.” The leases that will be the focus of the new standards are those greater than 12 months in length. However, there are several factors – such as are the agreements “extendable” – that may affect the analysis.
Then, under Topic 842, there are two types of leases: 1) Operating leases; 2) Financing leases. One of the provisions of this new standard is that all leases must be recognized on a company’s balance sheet.
For operating leases, ASC 842 requires recognition of a right of use asset (ROU) and a corresponding lease liability upon lease commencement. Then, as you make lease payments, those will be recorded as an expense and a reduction to the ROU(s).
Leases/contracts/agreements that qualify as financing leases under the new rules will be recorded on your institution’s books of account (at the present value of lease payments, with potential adjustments) as “ROUs.” Correspondingly, the liabilities associated with those ROU’s will be recorded as a “payable.” Future effects on your Statement of Activities will include Amortization expenses and Interest expenses – much like entries to record payments on bank loans.
When the rubber meets the road, for most of us, this will mean lease agreements/contracts with respect to copiers, audio/visual equipment, vehicles, internet equipment, etc. Contributions or donations of facilities or other items would generally not be considered subject to a “lease” under the new rules as they do not involve “consideration.”
For now, it is time to “inventory” all of the agreements and/or contracts that your institution is party to. Then, there is a five-step process to analyze with of these contracts might require the new treatment.
1. Identify all leases
2. Measure the term and consideration of each lease
3. Classify Leases: separate “operating leases” from “financing leases”
4. Disclose leases
5. Separate leases and contributions.
Further, as you “inventory” your leases, you need to be looking for “embedded leases.” These would be agreements/contracts that are ultimately classified as leases even though they are part of another agreement.
We will continue to unpack this new standard in future installments. For now, get busy on the “inventory” of your institution’s “leases.”
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