In June 2017, the Governmental Accounting Standards Board (GASB, or the Board) issued Statement No. 87, Leases (GASB 87), which establishes a single approach for local and state governments for all lease accounting and intends to account for certain lease liabilities that may not be currently reported in financial statements. The GASB wrote that the objective of GASB 87 “is to better meet the information needs of financial statement users by improving accounting and financial reporting for leases by governments.”1 Since then, GASB 87 has been a significant topic of conversation for many organizations, including adaptation and implementation of the single model for accounting and reporting. In this article, we cover the major changes required by the new standard as well as possible complexities that governments may face as they work toward compliance with the new lease standard.
Summary of Principal Requirements Found in GASB 87
- Effective Date and Transition – Government organizations are required to be compliant with the provisions outlined in GASB 87 for reporting periods beginning after December 15, 2019. As such, organizations are required to recognize and measure their leases as of the beginning period of the implementation. The Board considered allowing a prospective-only approach but was concerned with comparability of lease information under differing methods of reporting. It is significant to note that the GASB issued a proposed statement pertinent to governments that issue interim financial statements that would clarify the implementation date to be for fiscal years beginning after December 15, 2019, versus reporting periods beginning after December 15, 2019.
- Definition of a Lease – The GASB defines a lease as “a contract that conveys control of the right to use another entity’s nonfinancial asset (the underlying asset) as specified in the contract for a period of time in an exchange or exchange-like transaction.” The key wording changes in this definition from previous standards are contract, control, right to use and exchange. Right to use includes the right to obtain the present service capacity and the right to determine the nature and manner of use. Nonfinancial assets include land, buildings, vehicles and equipment.
- Lease Types – The GASB proposes a single lease type known as financing leases, which removes the distinction between what is currently known as operating and capital leases. The capital or operating lease classification previously depended upon whether the lease met any of four tests. The new standard removes the four tests and provides that a contract which transfers ownership of the underlying asset is treated as a purchase and reported as a financed purchase of the underlying asset.
- Lease Term – The lease term should represent the period for which the lessee and lessor are contractually (legally) obligated without the ability to cancel or terminate the contract. The timing was selected as such to mirror the definition of a lease, which is to convey control of another entity’s nonfinancial asset for a period of time. Renewal options in which the organization is reasonably certain to exercise should be included as part of the term for the liability calculation. Some factors to consider whether an option may be exercised include, but are not limited to, the following:
- Significant economic incentive, such as contractual terms and conditions for the optional periods considered favorable when compared with current market rates.
- Significant economic disincentive, such as costs for terminating and signing a new lease. Examples include costs related to negotiation, relocation, abandonment of significant leasehold improvements, etc.
- History regarding options to extend or terminate the lease.
- Extent to which the asset underlying the lease is essential for the government to provide services.
- Short-Term Leases – Short-term leases may be excluded from the financial statements as well as any ongoing disclosure requirements. GASB defines short-term leases as a lease with a maximum term of 12 months, including all renewal options regardless of probability of being exercised.
According to the new standard, the lessee is required to recognize a lease liability and a lease asset at the commencement of the lease term, unless the lease is a short-term lease or transfers ownership of the underlying asset. The lease liability is measured at the present value of payments expected to be made during the lease term. The lease asset is measured at the amount of the initial measurement of the lease liability, plus any payments made to the lessor at or before the commencement of the lease term (less any lease incentives) and certain initial direct costs. Both the lease asset and lease liability may be required to be remeasured if one of the following events occurs: a change in lease term, a change in circumstance surrounding the exercising of a renewal or termination option, a change in estimated amounts for lease payments or a change in the interest rate the lessor charges the lessee, if this is the rate the lessee used as their initial discount rate.
The lessor is required to recognize a lease receivable and a deferred inflow of resources at the commencement of the lease term, with certain exceptions for leases of assets held as investments, certain regulated leases, short-term leases and leases that transfer ownership of the underlying asset. A lessor should not derecognize the asset underlying the lease. The lease receivable should be measured at the present value of lease payments expected to be received during the lease term. The deferred inflow of resources should be measured at the value of the lease receivable plus any payments received at or before the commencement of the lease term that relate to future periods. A lessor should recognize interest revenue on the lease receivable and an inflow of resources (for example, revenue) from the deferred inflows of resources. Like lessee accounting, the lessor may be required to remeasure the lease receivable.
Notes to the Financial Statements
Both the lessee and lessor are required to disclose certain financial information regarding their lease activities, as evidenced by the chart below:
Complexities Of Leases
As we have learned from the implementation of the FASB’s accounting standard for public and private companies in the process of adopting, these requirements of GASB 87 provide unique accounting and reporting issues that governmental organizations could face as they implement the new standard. They include the following items:
- Identify/inventory leases – Search to account for all leases. This may include reconciliation of rent expense accounts, review of invoices, embedded lease searches, etc. Organizations may need to review contracts and expense accounts (rent, shortterm rent, etc.) to identify underlying assets that the organization controls that might not have been previously accounted for as leases.
- Measure the lease liability at the present value of the lease payments – The GASB outlines what the measurement of the liability and asset should include, such as variable and fixed payment stipulations as well as lease incentives. Organizations should review to ensure lease components are properly identified and that all appropriate inputs to the lease liability have been considered, e.g. fixed expenses versus variable expenses, lease renewal terms, etc.
- Related party leases require a close analysis of these transactions – Organizations need to ensure terms are not affected by the relationship of the parties. The nature and extent of the relationship between the parties should be also be disclosed in the notes to the financial statements.
- Identify regulated leases – Leases subject to stipulations based on the external laws and regulations that govern them may be excluded from the scope of this statement if they meet requirements outlined in GASB 87.
- Identify short-term leases – Short-term leases are excluded from the asset and liability reporting of the lease standard Short-term leases have a maximum life of 12 months, including all options regardless of desire to exercise.
- Identify all property, plant and equipment contracts – Inventory, supplies, biological assets, computer software and intangibles are excluded from requirements within GASB 87.
- Restate reporting periods – Organizations will need to historically restate all reporting periods included in the current year’s financial statements.
- Identify if a lease accounting system is in place – Governmental organizations should assess if they can handle the reporting necessary for compliance with the lease standard This will include systems to capture the various financial components of the lease for computing the liability and asset as well as providing information for the required footnote disclosures.
Whether you have yet to plan for the new standard or have already begun the required preparations, take some time with your trusted advisor to discuss the potential challenges your organization may face with implementation of GASB 87. For questions or more information on the implementation of the lease standard for governmental organizations, contact us at firstname.lastname@example.org, or reach out to one of the authors.
- Statement No. 87 of the Governmental Accounting Standards Board, Leases. June 2017.