New Leases Standard- ASU 2016-02, Leases (Topic 842)

On Tuesday, October 11, 2016, EisnerAmper’s own Jimmy Mo, Partner, and Heather Taylor, Director, presented a Not-for-Profit Industry Update that focused on two recent ASUs issued by the Financial Accounting Standards Board (FASB) that will have an effect on not-for-profit organizations. The Update provided an understanding of ASU 2016-02: Leases and ASU 2016-14: Presentation of Financial Statements of Not-for-Profit Entities, and also provided an understanding of their impact on not-for-profit organizations.

In this blog I will recap the presentation of ASU 2016-02, Leases (Topic 842) that was presented by Heather Taylor.  In a follow up blog I will cover the presentation on ASU 2016-14: Presentation of Financial Statements of Not-for-Profit Entities

FASB issued ASU 2016-02, Leases (Topic 842) on February 25, 2016 which presents dramatic changes to the statement of financial position. The new leases standard requires entities to recognize on the balance sheet (Statement of Financial Position) the assets and liabilities for the rights and obligations created by lease agreements.  The new leases standard is applicable to all leases except for leases of intangible assets, inventory and assets under construction. An entity could also establish an accounting policy to not apply ASU 2016-02 to short-term leases (12 months or less).

The FASB’s master glossary defines a lease as “a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (the identified asset) for a period of time in exchange for consideration.” The new leases standard maintains two classifications of leases: finance leases and operating leases.  Although both types of leases will include recording a similar right-of-use asset and lease liability on the balance sheet (statement of financial position), the subsequent measurement of the asset and liability differ and will affect the way the transactions are presented on the statements of operations (statement of activities) and cash flows. The right-of-use asset value includes considering the lease’s liability, initial direct costs, prepaid lease payments and lease incentives received.

The new standard expands the required footnote disclosures including the following:

• Qualitative Disclosures
• Information about nature of leases (and subleases), such as (1) general description, (2) basis, terms and conditions of variable lease payments, (3) extension and termination options, (4) residual value guarantees, and (5) restrictions and covenants
• Leases not yet commenced that create significant rights and obligations
  
  
• Quantitative
  
  • Finance lease cost, separating ROU amortization and interest on lease liability
  • Operating lease cost
  • Short-term lease cost
  • Variable lease cost
  • Weighted-average remaining lease term (separating finance and operating leases)
  • Weighted-average discount rate
  • Cash paid for amounts included in the measurement of lease liabilities, separately for finance leases and operating leases

For nonpublic business entities, the new standard will be effective for annual reporting periods issued for fiscal years beginning after December 15, 2019; thus it will be applicable for December 31, 2020 or June 30, 2021 year-ends for many not-for-profits.  Those dates may seem like a long time away and give all those not-for-profit controllers out there the impression that there is no immediate need to think about how the new leases standard will affect their organization.  However, the following easy steps can be taken now to prepare for the new leases standards and ensure a smooth application of the new leases standard.

• Consider business strategy before entering into new leases
  • Lease vs. buy
  • Short-term lease vs. long-term
• Identify all leases and gather all necessary information
• Discuss existing debt covenants with your bank that may be affected
• Consider the effect the new standard will have on covenants when negotiating new debt agreements