Understanding Lease Accounting for Non-Profits

Reminders: Applying ASC 842

The “new” lease standard – Accounting Standards Codification (“ASC”) Topic 842 – has been effective since calendar year 2022. Since implementation, there have been a few targeted improvements offered by the Financial Accounting Standards Board (“FASB”), intending to reduce diversity in practice and simplify the application of the standard for non-public business entities.

There are several provisions of ASC 842 that a not-for-profit organization might see only occasionally, which may make the organization uncertain of the appropriate guidance.

Free rent

If an organization is fortunate enough to be in a situation where it receives free use of an asset, whether it’s office space, event space, or equipment, it will have to record an in-kind contribution for that gift. The value of the unpaid rent is considered a contribution of a non-financial asset and would result in revenue for the organization (offset by a rent expense).

If an organization has a long-term agreement for free use of a space, there is effectively a promise to give that would be recognized upon the receipt of the agreement. It would be contribution revenue on the date of receipt, and the promise to give would amortize to rent expense over the life of the agreement.

However, there is no right-of-use asset or lease liability, as there normally is in the application of ASC 842. The value of right-of-use assets is based on the value of the related lease liability, which in turn is based on the present value of the future lease payments. Because there are no lease payments, there is no liability (and thus, right-of-use asset) to record.

Reduced rent

An organization may have to pay some rent, but the value may be below market. In this case, because there are future payments, there would be a lease liability and a right-of-use asset. These would be based on the future minimum lease payments, discounted back to present value, in accordance with ASC 842.

After that is recorded, the organization would record a contribution for the difference between the fair value of the rental and the stated lease payments. As in instances of free rent, this would be recorded as a contribution, and, depending on the nature of the underlying asset, may have an inherent restriction.

Periods of free rent

 An organization may be permitted to move into a space prior to the start of rent payments. The organization will have to determine whether this is a contribution or an inducement to sign the lease, indicating that its reflective of the underlying fair value of the rent. Regardless, it is important to remember that a lease commences when control of the underlying asset transfers to the lessee, regardless of when payment starts or the lease contract is signed.

Modifications

Whether it’s an extension of the term or space, or an early or partial termination, applying ASC 842 guidance to lease modifications can be very tricky. Some of the variables taken into consideration when evaluating include:

• Does the modification provide the right to use an additional asset?
  • If so, how is this additional right priced? Is it priced in a manner consistent with the original lease?
• Does the modification extend or reduce the term of the lease?
• Does the modification change the consideration required under the lease?
• Does the modification fully or partially terminate the lease?

Depending on the results of these questions, an organization may be required to reassess its lease classification and remeasure its lease liabilities and right-of-use assets. In some instances, the organization may be required to recognize a gain or loss as a result of its modification.

Conclusion

Accounting for leases can be difficult and tedious, whether you’re working with just one or a few dozen. This is especially true when there are significant changes in the organization’s lease agreements or portfolio. At such times, it can be good to reach out to your professional advisors to allow them to help you navigate the complexities of ASC 842.

If you have questions specific to your situation, please reach out to your Keiter Opportunity Advisor or Email | Call: 804.747.0000.

Special Lease Considerations for Non-Profit Entities