Remodeling Your Financials for New Lease Accounting – pop out an addition

Joan M. Renner, CPA, CGMA, Director 501(c)(fit!)

We’ve been talking about those home remodeling TV shows.  I love how they transform house after house from an outdated property into the latest style.  Sometimes they knock down a wall, sometimes they add a fire pit or even pop out an addition.  They make a big mess and usually find things they didn’t expect, but by the end of the show, they have a great update. 

By now, you know that new accounting standards have given you your own remodeling project–not on your home, but on your nonprofit’s financial statements.  In previous weeks, we’ve discussed a few of the effects of the new standard for nonprofit financial statements.  But, as if that’s not enough–wait, there’s more!  There’s also a new standard on accounting for leases.  This week, let’s discuss one aspect of that one, operating leases.  This remodel will be like popping out an addition.

For each of your operating leases, like your office lease, the new lease accounting standard will pop out a big addition on the liability side of your balance sheet.  This will be your lease liability.  It will be the present value of all your future lease payments.  That’s right, all your future office lease payments will now be a liability on your balance sheet at present value.  You’ll balance that out with a similar number on the asset side of your balance sheet, your right-to-use asset.  It’s like popping out two additions, one on each side of your house. 

As you move through the lease term, your lease liability and right-to-use asset will gradually get smaller.  You’ll recognize lease expense evenly over the life of the lease, and reduce the lease asset and liability based on the present value of remaining lease payments, following specific rules contained in the standard.  There are also rules for switching to the new standard, which we all must implement by 2020.

Why, why, why?  It’s hard to imagine why this is a better presentation, but this standard addresses real concerns from the for-profit world.  The old standard allowed two lease structures and one of them, operating leases, avoided the balance sheet.  Companies could manipulate financial results based on the lease structure.  Inconsistencies between companies made financial statements hard to compare.  So, even though nonprofits are just along for the ride, it’s valuable to have everyone report using the same rules.  The new GAAP applies to us too. 

What can we learn?

Now is a good time to become familiar with how the standard will affect your leases.  The new standard will change how lease expense is recognized and you’ll need to know expected lease expense when you prepare your budget.

Your Board and Finance Committee will need some time to get used to this.  Ask your accountant to calculate the effect and talk to your leaders in advance.  You wouldn’t want to just spring it on them. 

If you have notes payable with loan covenants, you’ll want to see in advance how the lease liability will affect your loan covenants and talk to your bank.

The new accounting standard for leases is Accounting Standards Update (ASU) 2016-02, Leases.  Its accounting and disclosure changes affect operating leases, capital leases/finance leases, subleases, lessors and lessees.

The new accounting standard for nonprofit financial statements is Accounting Standards Update (ASU) 2016-14, Presentation of Financial Statements for Not-for-Profit Entities.  Its accounting and disclosure changes include:

Restricted funds, board-designated funds, endowments, functional expense reporting, statement of cash flows, investment income and expenses, cash management policies and liquidity.

If you’re the accountant charged with implementing new standards, consider joining us for a detailed look at our live one-day seminar on November 3, 2017 in Alexandria, VA, Financial Intensive Training on the New Financial Reporting GAAP—Remodel Your Financials—an in-depth look. 

If you’re new to nonprofit finances, this is a great time for nonprofit managers and emerging leaders to become familiar with these new nonprofit financial statement features right from the beginning.  We’re including the basics in the Remodeling Your Financials  session of our live 2-day seminar, Financial Leadership Training for Emerging Nonprofit Professionals.

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