Guidance on Lease Standard for Independent Schools

What Lessees Need To Know

In February 2016, FASB issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) to increase transparency and comparability of lease transactions. Because of the significant changes contained in this ASU, though issued in 2016, the effective date for implementing the new accounting guidance was pushed to fiscal year 2023 for independent schools.  FASB has taken advantage of the period between issuance and effective dates to provide various improvements and practical expedients.  AAFCPAs outlined below the significant changes resulting from the new ASU for your convenience, and we review and discuss practical expedients and improvements.

This ASU applies to all independent schools that enter into a lease. There is no significant change to the lessor accounting, except for the classification of the leases.  The most significant change is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under existing GAAP (generally accepted accounting principles).

Operating leases will now be recorded in the balance sheet as assets and liabilities if the lease term is greater than 12 months. Prior to this new standard, U.S. GAAP required only capital leases to be recognized on the balance sheet.  This recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under existing GAAP is a very significant change to all reporting entities and will require significant analysis and evaluation.

For leases with a term of 12 months or less at commencement, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities and recognize the lease expense generally on a straight-line basis over the lease term.

Lessees are required to:

• Recognize a right-of-use (ROU) asset and a lease liability;
• Measure both the ROU asset and the lease liability at the present value of the remaining lease payments;
• Capitalize initial direct costs as part of the ROU asset;
• Optional exemption for short term leases (< 12 months); and
• Each year the ROU asset should be assessed for impairment.

AAFCPAs provided a detailed Whitepaper on the FASB’s new Lease standard, and encourages clients to proactively consider the impact on their current and future operations. This Whitepaper outlines the significant changes resulting from the new ASU, including: a comprehensive outline of the scope of the new lease standard, effective dates, disclosure requirements, and practical considerations for lessees and lessors. Download AAFCPAs’ Lease Accounting Whitepaper. >>

Common Questions and Answers for Independent Schools

Question 1: The school owns its buildings. Does ASC 842, Leases apply to us?

Answer: It depends. Although the school might not have any building leases, it could have leases related to copiers, telephones, laptops, etc. AAFCPAs advises clients to conduct a thorough review of its contracts with vendors to ensure no embedded leases.

Question 2: The school sub-leases their facilities (gymnasium, boat house, athletic field, etc.) during the summer months. How should the school account for the sub-lease?

Answer: The school can elect to not apply recognition requirements if they deem the sub-lease to be a short-term lease or an immaterial lease. If not deemed to be a short-term lease or immaterial, the school would straight-line the rental income and record rental income over the term of the lease.

Question 3: The school has long-term contracts with outside service vendors (i.e., bookstore operations, food management services). How should the school account for these contracts?

Answer: It is important to review contracts for embedded leases. Bookstore operations would probably not fall under ASC 842 because there is no underlying asset that is being leased. Food management services could fall under ASC 842 if the contract states that the school is leasing kitchen equipment or appliances. If so, the school would need to work with the vendor to determine the amount of payment related to the equipment and appliances and apply that to the ROU asset and lease liability calculation.

Question 4: The school has debt covenants with its financial institution. How will the adoption of ASC 842, Leases impact the school’s financial covenants?

Answer: The adoption of ASC 842 could impact schools’ statements of financial position with newly added right-of-use assets and related lease liabilities. These changes in financial position will result in increased debt levels which could negatively impact debt covenants such as debt to equity ratios, liquidity ratios, etc. AAFCPAs advises clients to work with their financial institution to work through changes in debt covenants in consideration of the impact of ASC 842.

Question 5: The school has an agreement with a vendor for an online learning program for the purposes of marketing, promoting, and delivering e-learning programs to students. Under the agreement, the school is obligated to contribute the academic and educational content to students while the vendor is obligated to contribute intellectual property, including a platform for delivering e-courses. How should the school account for this contract?

Answer: It depends. If the contract dictates that the school remit to the vendor a percentage of tuition collected for courses administered, then this would not fall under ASC 842 as it is a variable payment. However, if the contract states there is a monthly lease payment for usage of the e-learning platform, then those monthly payments would fall under ASC 842.

If you have questions about how the new Lease ASU will impact you, please contact Aaron Diamond, CPA at 774.512.4182, adiamond@nullaafcpa.com; John Buckley, CPA, CGMA, at 774.512.4039, jbuckley@nullaafcpa.com; or your AAFCPAs partner.