Are you an owner, developer, or property manager of an affordable housing development? If so, continue reading to learn more about how the implications of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 842 Leases may affect your organization. This standard has been a long time coming and is effective for fiscal years beginning after December 15, 2021.
When looking at the changes from this standard, there are two things to consider from both the lessee and lessor perspective for an owner, developer, or property manager.
ASC 842 Impacts to a Lessor
Lessors classify a lease with any of the following criteria as a sales-type lease:
- Lease transfers ownership of underlying asset to lessee by end of lease term.
- Lease grants lessee option to purchase underlying asset that lessee is reasonably certain to exercise.
- Lease term is for a major part of the remaining economic life of underlying asset (most companies use 75% as the threshold).
- Present value of sum of lease payment and any residual value guaranteed by lessee is greater than or equal to substantially all fair value of the underlying asset (most companies use 90% as the threshold).
- Leased asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of lease time.
If the lease does not qualify as a sales-type lease, but both of the following criteria are met, the lease is classified as a direct financing lease:
- Present value of the sum of lease payments and any residual value guaranteed by the lessee and/or any third-party payments unrelated to the lessor are greater than or equal to substantially all of the fair value of the underlying asset. The main distinction in this step versus the similar step in the sales-type lease evaluation is third-party payments which can be included in the present value calculation, like residual value guarantees from a third party to reduce their risk in the residual value of the asset.
- Probable that the lessor will collect the lease payments plus any amounts necessary to satisfy a residual value guarantee
Most leases for residential affordable housing will qualify as an operating lease as they do not meet the definitions mentioned above for classification as a sales-type or direct financing lease. The good news is this likely will not result in significant changes to your financial statements or disclosures. The primary changes include a requirement to report cash receipts from operating leases within operating activities in the cash flow statement and additional disclosure requirements. You will also want to consider if your property has other lease agreements that the property serves as a lessor for such as commercial tenants. This could lead to additional disclosures.
ASC 842 Impacts to a Lessee
Some common examples of lease agreements that may impact an owner, developer, or property manager include:
- Ground leases on which an affordable housing property is located
- Equipment used at the property (i.e. copiers, computers, etc.)
- Leased buildings or other facilities
As a lessee, the entity will need to evaluate if the lease meets the recognition guidance to qualify as an operating lease or a finance lease. If any of the following criteria to qualify are met, the lessee will record a finance lease:
- The lease transfers ownership of the underlying asset by the end of the lease term
- The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise
- The lease term is for the major part of the remaining economic life of the underlying asset
- The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all of the fair value of the underlying asset
- The underlying asset is such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term
As a lessee, if the lease does not qualify as a finance lease, it is classified as an operating lease.
The lease agreement establishes a contract in which consideration is exchanged and a right to use asset is established for either a period of time or an amount of use. This will establish an asset on the balance sheet as well as a corresponding liability on the balance sheet regardless of whether the lease is classified as an operating or a finance lease. It is important to understand how these changes to the financial statements may impact any investors or regulators involved in the affordable housing property.
Whether you have one lease or hundreds, we have a solution to fit your unique ASC 842 adoption needs. For additional information, please view our recent webinar focused on the implementation of ASC 842.
McKonly & Asbury, LLP is a leader in accounting for affordable housing partnerships. Our team has the specialized knowledge to help you ensure you comply with IRS and tax credit allocating agency reporting requirements. For more information on these services and more be sure to visit our Affordable Housing page, and don’t hesitate to contact us.