This article, "What Nonprofits Need to Know About ASC 842," originally appeared on LeaseQuery.com.
ASC 842 at a glance
ASC 842 is the new FASB lease accounting standard. It governs how entities record the financial impact of their lease agreements. The biggest change is the standard now requires all public and private entities reporting under US GAAP to record most of their leases to the balance sheet.
For more information about implementing ASC 842, check out LeaseQuery’s Ultimate Lease Accounting Guide.
Impact on nonprofits
Under the previous guidance, ASC 840, a finance lease required nonprofits to disclose a large liability to show the nonprofit was contractually obligated to make future payments. Under ASC 842, both finance and operating leases must be reported on the balance sheet. The new rule provides better transparency into a nonprofit’s financial commitments for the future.
ASC 842 is effective for fiscal years beginning after Dec. 15, 2021. While various entities have already been required to implement the standard, such as public entities, not-for-profit organizations have a little more time, though implementation should be underway. Many nonprofit organizations are working through the lease accounting transition for the 2022 year-end.
The new disclosures
Under ASC 842, companies are required to disclose the following lease information:
- Discussions covering the lease arrangements
- Descriptions of significant judgments made
- Certain details about the operating and finance lease amounts recognized in the financial statements
- Weighted-average analysis of discount rates and remaining lease terms
The updated disclosures will provide donors and other users of financial statements with more insight into a not-for-profit’s financial obligations and the impact on the organization’s performance.
Preparing for the transition
Implementing the new ASC 842 lease accounting standard will run smoothly if you use the tips outlined below. Download LeaseQuery’s ASC 842 Transition Checklist for additional guidance during adoption.
Collect lease data
The first and most crucial step of implementation is collecting the lease data. Create an inventory of leases from all entities, departments, and locations. Evaluate each contract to determine the scope and find any embedded leases.
Have a small lease inventory? LeaseGuru makes it simple and secure to account for 1-15 leases under ASC 842.
Classify your leases
The new FASB standard continues to use a two-model approach for lessees; finance and operating. There are five tests to help determine lease classification:
- Transfer of title/ownership to the lessee
- A purchase option the lessee is reasonably certain to exercise
- Lease term is over a major part of the economic life of the asset
- Present value equals or exceeds substantially all of the fair value of the asset
- Asset specialization: Would it provide any value to the lessor after the lease term?
If a lease does not meet any of the five criteria, it is an operating lease. Learn more about the criteria here or use LeaseQuery’s Finance vs. Operating Lease tool to determine if a lease is classified as a finance or operating lease under ASC 842.
Update internal controls
ASC 842 provides a great opportunity to update accounting procedures and internal controls. Nonprofits can benefit from creating new internal controls or updating the existing ones.
Ideally, organizations have a process in place to identify whether their agreements contain potential lease agreements or not. How will the nonprofit document new, modified, canceled, or discontinued lease agreements? Procedures created to ensure accounting is notified of all new lease or purchasing contracts will establish a complete lease portfolio easily.
Remember, this is an ongoing process
While making it through the transition and achieving compliance is an accomplishment, the journey doesn’t stop there. Day 2 lease accounting still poses challenges, such as:
- New balance sheet and income statement accounts
- Additional close procedures
- Knowledge of and accounting for lease activity
- Internal controls
After implementation, nonprofits should determine what subsequent lease accounting will look like. Read this blog about Day 2 lease accounting to learn more.
The stress of transitioning to the new FASB standard can seem overwhelming. If you need some guidance on implementing the new standards, LeaseQuery is here to simplify the complex with our easy-to-use software.
Download our Ultimate Lease Accounting Guide and take the corresponding Masterclass to feel confident in your ASC 842 transition.