Lease Standard Education Series for Nonprofits – Lease Standard Basics
When building a house, it is important to have a solid foundation. Same is true when implementing the new lease standard. In this blog, we summarize some of the key pieces of the new lease standard that can help you build your educational foundation.
Lease Commencement Date and Arrangements
Under ASC 842, a lease is classified, recognized, and initially measured on the commencement date of the lease, or the date the lessor makes the underlying assets available to the lessee (the nonprofit in most cases) for its use.
When it comes to differentiating between what leases are operating verses financing arrangements, the process has not significantly changed from prior standards. The below table illustrates when a lease arrangement is an operating or financing arrangement under the new lease standard:
Definitions:
“Major part” means:
- 75% or more of remaining economic life of the underlying asset, or
- A commencement date that falls at or near the end of the economic useful life refers to a commencement date that falls within the last 25% of the total economic life
“Substantially all” means:
- 90% or more of the fair value of the underlying asset
“Lease term” means:
- The noncancelable period of the lease, together with (a) periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option, (b) periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option and (c) periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor.
“Lease payment” means:
- Fixed payments, less any lease incentives paid or payable to the lessee.
- Variable payments that depend on an index or rate.
- The exercise price of an option to purchase if lessee reasonably certain to exercise option OR penalties for terminating the lease if it is likely the lessee will exercise that option.
- Amounts probable of being owed under residual value guarantees, if applicable.
Lease Liability and Right of Use (ROU) Asset Calculations
Initial Measurement
For the initial measurement of the lease liability, the lessee discounts the lease payments not yet paid over the lease term using the discount rate as of the commencement date. This present value calculation is used regardless of the lease arrangement noted above.
As for the initial measurement of the ROU asset, the lessee starts with the lease liability and then adjusts accordingly:
Under ASC 842, the definition of initial direct costs is narrower than under previous lease standards. Initial direct costs only include those incremental costs to obtain a lease that the lessee would not have incurred if the lease was not entered into. An example would be commission paid to an employee only after the lease was agreed upon. Fees for legal review or allocated costs like salary and benefits of employees or depreciation expense of used office and equipment would no longer qualify as initial direct costs.
As for lease incentives, those include payments made to or on behalf of the lessee. If paid on or before the commencement date, they should reduce the lease liability for purposes of measuring the ROU asset but should not be used to reduce lease payments for purposes of measuring the lease liability. If not yet paid (payable) on or after the commencement date, the opposite consideration is needed.
Subsequent Measurement
After the initial year, the subsequent measurement of the lease liability and ROU asset are calculated as follows:
How CLA Can Help?
The new lease standard is here. Take proactive steps today to understand its impact on your nonprofit. CLA has the lease resources to help assess its impacts beyond general accounting and financial reporting, and walk you through readiness assessment, software selection and analysis, and implementation.
A turnkey lease accounting option can include:
- Assistance to identify and analyze leases that are subject to the standard
- Delivery of leased asset schedules, journal entries, and comprehensive footnote disclosures
- Updated and revised information at future interim or annual periods based on your needs
Lease Education Series
Stay tuned! In our next post we are taking a dive deeper into this new standard, looking at discount rates.
In case you missed or would like to recall upon any prior content, below is a running list of the educational series:
Lease Standard Education Series for Nonprofits – Series Introduction
Comments are closed.