Accounting for Nonprofits: ASC 842 Standards & Regulations

Much like their for-profit counterparts, nonprofits must also follow specific financial reporting standards, including Accounting Standards Codification (ASC) 842. This blog post will delve into the essential aspects of ASC 842 regulations and answer common questions like how ASC 842 applies to nonprofits and how it may impact non-profit organizations. Additionally, we will explore the world of Generally Accepted Accounting Principles (GAAP) applied in nonprofit accounting.

Understanding ASC 842

ASC 842 is a set of accounting standards developed by the Financial Accounting Standards Board (FASB). These standards specifically pertain to leases and were introduced to enhance transparency in lease accounting, providing a more accurate representation of an organization’s financial position. While ASC 842 is primarily associated with for-profit entities, it is important for nonprofits to understand its relevance as well.

One of the core mechanics of the standard is that most leases longer than 12 months are now recorded as both a right-of-use asset and a lease liability bringing lease obligations onto the balance sheet rather than leaving them in the footnotes.

Does ASC 842 Apply to Nonprofit Organizations?

Yes, ASC 842 applies to nonprofit organizations that follow GAAP. If a nonprofit leases office space, equipment, vehicles, or other assets for more than 12 months, those leases may need to be recorded under ASC 842. Recording a right-of-use asset and lease liability does not mean the nonprofit has taken on new debt. It makes existing lease obligations more visible in the financial statements. This applies to both operating leases and finance leases, though the accounting treatment varies by classification.

Nonprofit organizations often enter into leases to support programs, administrative operations, fundraising, and community services. Even organizations with only a few lease agreements should review their contracts carefully to determine whether ASC 842 applies.

ASC 842 Effective Date for Nonprofit Organizations

ASC 842 became effective the fiscal year beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020.

Today, the focus is on maintaining accurate lease records, identifying new or modified lease agreements, reviewing embedded leases, and keeping disclosures up to date.

GAAP Accounting for Nonprofits

Nonprofit organizations, like for-profit entities, must adhere to Generally Accepted Accounting Principles (GAAP) when preparing their financial statements. ASC 842, being a part of GAAP, falls under these principles.

GAAP accounting for nonprofits is designed to provide transparency and accuracy in financial reporting, ensuring that donors, grantors, and other stakeholders have a clear understanding of the organization’s financial health. Compliance with ASC 842 is crucial not only for meeting regulatory requirements but also for maintaining the trust of donors and supporters.

Key ASC 842 Provisions for Nonprofits

Several ASC 842 provisions deserve attention from nonprofit finance teams.

• Asset and liability recognition: For operating leases, the ROU asset generally equals the lease liability, adjusted for prepaid rent, initial direct costs, and lease incentives received.
• Embedded leases: The definition of a lease extends beyond standard lease contracts to include embedded leases. Service contracts such as IT hosting agreements, photocopier contracts, or vehicle arrangements that grant exclusive use of an underlying asset may need to be separated and capitalized.
• Discount rates: Determining a discount rate can be challenging when the rate implicit in the lease is not readily available. Nonprofits may elect to use a risk-free discount rate, such as a Treasury rate, to simplify the calculation process.
• Below-market and donated leases: Nonprofits frequently enter into below-market leases, rent-free agreements, or donated space arrangements. Under ASC 842, these are recorded at fair value. The difference between the fair market value and the rent actually paid is typically treated as an in-kind contribution and a related rent expense.
• Short-term lease exemption: Leases with a term of 12 months or less may be excluded from balance sheet recognition if the organization makes the proper accounting policy election and there is no purchase option reasonably certain to be exercised. Payments on these leases continue to be expensed as incurred.

Impact on Nonprofit Financial Statements

Given that ASC 842 increases total reported assets and liabilities, it can affect debt covenants, grant compliance, and liquidity ratios tracked by lenders and federal grantors.

This does not mean the organization is in a weaker financial position. It reflects a change in how lease obligations are reported. Communicating this internally is important so boards, donors, and other stakeholders understand that the increase in liabilities reflects reporting standards, not sudden financial distress.

How Nonprofits Can Ensure ASC 842 Compliance

Nonprofit organizations can ensure ASC 842 compliance by taking several proactive steps. Here are some key actions to consider:

• Educate Your Team: Make sure finance and accounting teams understand ASC 842 requirements, including embedded leases, discount rate elections, and disclosure obligations.
• Identify Lease Agreements: Build a complete inventory covering real estate, office space, vehicles, equipment, and other leased assets.
• Gather Lease Data: Collect lease terms, payment schedules, renewal options, termination clauses, and purchase options for each agreement.
• Assess Lease Classification: Determine whether each lease is an operating lease or a finance lease, since the accounting treatment differs.
• Review Vendor and Service Contracts: Look for embedded leases in IT, equipment, transportation, and facility agreements.
• Document The Discount Rate: Record how the discount rate is determined for each lease or asset class. If the risk-free rate election is used, apply and document it consistently.
• Review Below-Market and Donated Arrangements: Confirm that fair value, in-kind contribution, and rent expense are recorded correctly.
• Develop Policies and Procedures: Create controls for initial recognition, subsequent measurement, and financial statement disclosure. Notify finance whenever a department signs, renews, or modifies a lease.
• Keep Disclosures Current: ASC 842 includes specific disclosure requirements. Financial statements should explain lease obligations clearly.
• Consider Technology Solutions: Lease accounting software can centralize lease data, track key dates, manage calculations, and maintain documentation, which is especially helpful for organizations with multiple locations, departments, programs, or lease types.

By proactively preparing for ASC 842 compliance, nonprofit organizations can ensure accurate financial reporting, maintain transparency, and meet regulatory requirements, ultimately safeguarding their financial stability and reputation.

How Lease Accounting Software Can Help Nonprofits

Managing lease accounting manually can be difficult, especially when nonprofit teams are already balancing limited resources, audit requirements, grant reporting, and internal controls. Technology can help create consistent workflows for lease review, approval, tracking, and reporting.

Schedule a demo with Visual Lease to see how our lease accounting software can help your nonprofit stay compliant with ASC 842.