One of the key changes brought in by the new Charities Statement of Recommended Practice (SORP) is how leases are reported in charity accounts, which will affect some organisations in the charity sector.
The new SORP is designed to bring charity accounting up to date with changes in wider accounting standards, as well as making reporting clearer, more transparent, and more useful for stakeholders.
Many trustees and charity managers will be aware that the extent to which wider financial reporting is affected by the new rules depends on the size of the charity, as measured by its annual income and/or its assets. But the changes to lease accounting are applicable to every charity, regardless of its size.
Up until now, whilst charities may have finance leases on the balance sheet, most have typically been treated as operating leases, which means that the lease payments are recognised as an expense, and the leased asset have not appeared on the charity’s balance sheet.
The new rules change this; all leases will now have to be shown on the balance sheet. This will mean recording both a right-of-use asset (representing the item being leased) and a lease liability (reflecting the payments owed against the lease).
The effect of this for many charities will be that their balance sheet will show higher assets and liabilities, potentially pushing a charity through an audit threshold. This could also impact cash flow statements, as well as affecting metrics such as KPIs and debt covenants.
There are a couple of exemptions: short-term leases with a term of 12 months or less at the commencement date and leases involving low value assets (such as computers, phones and small office furniture items). Here lease payments can continue to be recognised as an expense in the charity’s accounts, the leased asset and liability do not need to be included on the balance sheet.
There are a number of things that charities need to be doing to ensure they comply with the new requirements:
Review all of their existing leases, consider whether any exemptions apply.
Update their systems to track assets and liabilities.
Ensure that notes to accounts include all relevant details about leases.
Consider the impact of the changing recognition, for example for bank covenants, or on whether the charity breaches the asset-related audit threshold.
If your charity has entered into an agreement where the lease payments are below market value (for example on some premises), trustees will need to consider the substance and terms of the agreements. This is a complex area, and professional advice is recommended.
If charities are unable to determine the interest rate implicit in the lease, they can use the interest rate it can obtain on deposits held with financial institutions.