Leases Part 5: Specific Issues for Not-for-Profit Entities Under the New Lease Standard
By Janey Kuyath, CPA and Benjamin R. Ripple, CPA, Partner
Not-for-profit entities will face some unique issues when adopting the new lease standard. Not-for-profits will have to go through the processes of determining whether a lease is operating or financing and recording the activity for those amounts, which we have covered in prior articles in this series. The wrinkle that makes this unique for the not-for-profit industry is that it is common for a not-for-profit to receive either use of a donated space or engage in below market lease agreements. In this article, we will look to address what a not-for-profit should do when it engages in one of these agreements.
The new lease defines a lease as a contract that conveys the right to control the use of identified property and equipment for a period of time in exchange for consideration. It then goes on to define consideration as cash and other assets exchanged in the transaction, as well as non-cash considerations.
This leads us to evaluate two types of below market activities entered into by not-for-profits:
- Fully donated use of property or equipment, and
- Below market leases.
Fully donated use of property or equipment does not qualify as a lease under the new standard, as there is no consideration exchanged on behalf of the not-for-profit. Therefore, the donation should be recorded as a promise to give valued at the present value of the lease payments computed as noted in previous articles. For the below market leases, the cash payments should be used as the consideration from the lease, and the remaining difference between what is being paid and market value should be treated as a promise to give similar to how the fully donated use is recorded.
To help illustrate how these would be recorded, we will look at three examples: fully donated use of property, a below market operating lease, and a below market financing lease. All three examples will use the assumption that the not-for-profit is leasing office space as lessee (tenant) with an assumed market rate of $30,000 annually, and we will use a discount rate of 5%. This gives us a present value of $81,697 at the beginning of the lease, $55,782 at the beginning of year 2, and $28,571 at the beginning of year 3. For examples 2 and 3, we will assume that the not-for-profit is paying $5,000 annually over the three-year period. This gives us a present value of $13,616 at the beginning of the lease, $9,297 at the beginning of year 2, and $4,762 at the beginning of year 3.
Example 1: Fully Donated
Here are the balances that should be recorded assuming the space is fully donated:
The amounts at inception represent the present value of the contribution. The annual rent expense represents the market value of the donated space. The amounts of contributions after inception reflect the amortization of the discounted receivable, and get the total contributions in line with the total rent expense over the three years that were donated.
Example 2: Below Market Operating Lease
Here are the balances that should be recorded assuming that the below market lease is classified as an operating lease:
Example 3: Below Market Financing Lease
Here are the balances that should be recorded assuming that the below market lease is classified as a financing lease:
As you can see, these donated and below market leases can get complicated really quickly, and these examples did not even go into the difficulties and assumptions that can go into getting an accurate fair market rent value. If you are currently involved in such a leasing arrangement, we urge you to reach out to your accounting service providers to get a jump on implementation of the new lease standard.
Benjamin R. Ripple Partner, Assurance Practice Leader, CPA
Ben is a partner in BRC’s assurance services. Since starting his career in 2001, Ben has worked with clients ranging from family-owned companies, to multinational corporations, to not-for-profit and governmental entities requiring A-133 audits. Ben’s industry experience includes: Manufacturing and distribution Hospitality, including restaurants and hotels Investment companies Governmental and not-for-profit entities Affordable housing […]