By Keiter CPAs
ASC 842: Recognizing below market rent payments and donated space
While private companies and non-profit entities with calendar year-ends were required to adopt Accounting Standards Update 2016-02 under Accounting Standard Codification 842 (ASC 842) for the year ended December 31, 2022, many fiscal year non-profit entities are currently going through the process of adopting the standard. This article focuses on special considerations unique to the non-profit industry.
Under ASC 842, a lessee is required to recognize a lease liability measured at the present value of the remaining lease payments using the rate implicit in the lease, if known, or an accounting policy election can be made to use the risk-free discount rate. A corresponding right-of-use asset is measured using the sum of the following:
- The lease liability at the beginning of the lease +
- Lease payments made to the lessor on or before the commencement date +
- Any initial direct costs that the lessee incurred
However, challenges arise when a non-profit entity enters into a lease contract with required lease payments at below market rates. Additionally, there are situations where a non-profit entity may receive in-kind contributions of donated lease space.
Nonprofit entity below market rent payments
In situations where the non-profit entity is making below market rent payments, the initial lease liability should be measured at the present value of the unpaid lease payments using the discount rate selected when the lease was initially recognized. The right-of-use asset should equal the lease liability adjusted for the factors noted in the above paragraph. In addition to the right-of-use asset and lease liability, the non-profit entity will recognize the difference between the fair-market value of the lease payments and the actual lease payments as a contribution, which should be recognized in accordance with ASU 958-605-55-24.
Nonprofit entity lease agreement
If a non-profit entity receives an unconditional promise to use property in a lease-type situation where no payments are required or the payments can be considered de minimis, contribution revenue (donor-restricted support) and a contribution receivable should be recognized when the organization receives the unconditional promise. The amount recognized as contribution revenue is the difference between the fair rental value of the property and the rental payment amounts, not to exceed the fair value of the asset at the time the non-profit entity receives the promise. If no period is specified, the non-profit entity should recognize the fair value of the rental payments as contribution revenue and rent expense on a periodic basis. Rent expense should be based on the fair rental value, rather than the actual lease payments made.
ASC 842 Example: Recognizing donated space for nonprofits
Background: Non-profit entity enters into a lease agreement for office space on July 1, 2022, requiring monthly payments of $1,000 for a three-year period and has elected to use the risk-free rate at the lease commencement date (2.85%). The lease has been determined to be an operating lease under ASC 842. The fair market rental value for a similar office space is determined to be $4,000.
| Entry at Lease Commencement Date: | |
|---|---|
| To record right-of-use asset and lease liability - July 1, 2022 | |
| DR: Right-of-use operating lease asset | $34,547 |
| CR: Operating lease liability | $(34,547) (a) |
| To record contribution receivable and contribution revenue | |
| DR: Contribution receivable | $108,000 (b) |
| CR: Contribution revenue | $(108,000) |
| Monthly entries thereafter: | |
| To record amortization of right-of-use asset and lease liablility | |
| DR: Lease Expense | $1,000 |
| DR: Lease Liablility | $947 |
| CR: Accumulated Amortization | $(947) |
| CR: Cash | $(1,000) |
| To record amortization of right-of-use asset and lease liablility | |
| DR: Lease expense | $3,000 (c) |
| CR: Contribution receivable | $(3,000) |
| (a) Equal to present value of $1,000 payment over a 3 year period at 2,85% | |
| (b) Equal to ($4,000x36) - (1,000x36). Calculation of the present value was not considered necessary for this illustration. | |
| (c) Equal to fair market rental value of $4,000 less $1,000 payment | |
Questions on recognizing donated space for your not-for-profit entity? We can help. Contact your Keiter Opportunity Advisor or Email | Call 804.747.0000
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Keiter CPAs
Keiter CPAs is a certified public accounting firm serving the audit, tax, accounting and consulting needs of businesses and their owners located in Richmond and across Virginia. We focus on serving emerging growth businesses and companies in the financial services, construction, real estate, manufacturing, retail & distribution industries and nonprofits. We also provide business valuations and forensic accounting services, family office services, and inbound international services.
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