Why Nonprofits Shouldn’t Wait to Prepare for the New Lease Accounting Standards
By Scott M. Brenner | August 5, 2019
The FASB Accounting Standard Update (ASU 2016-02) was passed on February 2016 and updated the lease accounting rules (ASC 842) for all entities. Originally effective for non-public entities for years beginning after December 15, 2019, FASB has now delayed the implementation until years beginning after December 15, 2020, for non-public companies and not-for-profit organizations. However, the time for these organizations to prepare for these new standards is still now.
A detailed overview of ASU 2016-02 was written in the Q2 2018 issue of the Nonprofit & Government Times newsletter. As a quick recap, under the new standard, leases (other than short term leases of 12 months or less) must be recorded by recording an intangible asset and a corresponding liability. The asset (right-to-use intangible asset) and liability (the lease liability) are recorded at the net present value of the lease payments over the life of the lease. The accounting for the lease will require an interest component and the intangible asset will be amortized over the life of the lease.
This means that there is no longer any rent expense for budgeting purposes. On the income statement, an organization will have amortization expense of the asset and interest based on the amortization of the lease liability. Over the life of the lease, the interest and amortization expenses will approximate what the rent expense would have been. The cash outflow from the lease will not change. It just changes how leases are accounted for.
This leads to the question: how will this affect a nonprofit’s budgeting process?
Budgeting for the New Lease Standard
There are several options to adjust to the new lease accounting standard when organizations begin to budget for 2020 and beyond. Listed below are three options for how to approach the budget process.
Option One: Budget for the cash outflow of the lease
In other words, budget for the amount paid to the landlord every month. While this allows the nonprofit to manage the cash flow of the organization on a month-by-month basis, the downside is that the income statement will not be in sync with the actual cash flow, since there is a lease liability principal reduction component of the lease payment every month that is not accounted for on the income statement.
Option Two: Budget for the expenses and liabilities of the lease
This variation would create line items on the budget for all components of the monthly lease payment (interest, amortization, liability principal reduction). This would keep the income statement “pure” and help the organization match up to its budget with its operations. However, the liability principal reduction is a reduction of a balance sheet account and would not be included in the operating statement. The principal liability reduction could be listed “below the line” for budgeting purposes so that the organization can have a true operating measure for their budget.
Option Three: Continue to budget the payment as rent expense.
This is by far the easiest approach but would not match up with accounting.
Choose Your Option Now
Like any modification to the budget process, changing your organization’s lease accounting methodology should be planned far in advance. Before the changes take effect in 2021, finance directors should consider which option they feel is the best fit for their organization and Board.
This decision should include input from the executive director and program directors about how this change in lease accounting will affect the way they look at their budget and compare it to the actual metrics for their organization and individual program areas. The finance committee and treasurer should also weigh in on whether they are able to provide the necessary information.
Finally, if bank information on loan covenants (in relation to budgeting) is required, finance directors should speak to their bankers about this shift in lease accounting. Organizations should also look at their current contracts to see if there are any embedded leases in those contracts.
The changes to lease accounting will influence how most nonprofit organizations budget in the years to come. If not properly thought through, the lack of preparedness can have a distinct ripple effect on the organization and their ability to measure performance against budget on a variety of levels.
About Scott M. Brenner
Scott M. Brenner, MBA, CPA, CFE, is a Partner at Marks Paneth LLP, where he provides attest, accounting and advisory services to both for-profit and not-for-profit organizations. To this role, he brings more than 30 years of experience in the manufacturing, government and nonprofit industries. He also advises privately held business owners on tax planning strategies and the use of pensions as tax-savings tools. Prior to joining Marks Paneth, Mr. Brenner was the Managing Partner... READ MORE +