It may not be glitzy and glamorous, but like The Great Gatsby, GASB 87 deals with appearances versus reality.
And so does its nongovernmental counterpart, FASB 842.
In fact, the aim of all the new lease accounting standards is to make a reporting entity’s financial statements more transparent, thereby reflecting a more accurate picture of its financial health. This is true especially with regards to the economic substance of its leases.The new lease accounting guidance from all three boards moves substantially all leases onto the balance sheet. There are other changes, but that shift is the major, monumental one that will impact an entity’s financials the most.
Up till now, both private and public companies as well as governmental entities have been allowed to disclose operating leases only in the footnotes.
But the problem with not including operating leases on the balance sheet is that an organization can look as though it has far fewer liabilities than it actually does. Appearances vs. reality.
Thus, the new lease accounting standards were issued--which public companies needed to comply with in 2019. The 2020 deadline for private companies was moved up a year allowing them more time to complete the complex task of implementation.
With the GASB effective date less than one year away, governmental reporting entities still have a significant amount of work to do to implement GASB 87.
According to Cherry Bekaert’s 2019 Annual State and Local Government Benchmarking Survey, 45% of respondents had started compiling their lease data, but only 7% of those surveyed had started to build a database with their lease terms and another 16% had appointed someone internally to head up the project.
Recognizing that the tools of automated technology will ease the implementation process considerably, 67% reported they were considering expanding to cloud-based software solutions.
GASB 87 Lease Basics
The Governmental Accounting Standards Board (GASB) published GASB Statement No. 87, Leases, in June 2017. State and local governmental organizations that follow US generally accepted accounting principles (GAAP) are required to comply with the new lease accounting rules which become effective for reporting periods that begin after December 15, 2019.
Several similarities exist between GASB 87 and FASB 842 (and IFRS 16). First, there is the timing of their release. The overhaul of lease accounting policies has been desired for many years now. Although GASB trailed behind the other boards in starting its lease accounting project, it did so in order to maximize efficiency while still aligning, for the most part, with the decisions made by FASB and IASB.
Second, there’s the all important change in the way operating leases are accounted for. The new guidance calls for a right-of-use asset and its corresponding liability to be recorded on an entity’s balance sheet, not just in the footnotes.
Furthermore, leases with terms of 12 months or less are excluded, and the new standards don’t apply to leases for inventory, intangibles, natural resources, biological assets, service concessions and supply contracts.
And that’s where the similarities end.
The legacy GASB guidance mirrored ASC 840, meaning governmental entities accounted for leases much the same way public and private companies did--with two classifications of leases, and only those classified as finance leases were required to be capitalized on the balance sheet.
So it was expected that when the new lease accounting rules outlined in GASB 87 were released, they would follow suit and match FASB once again.
But GASB’s new guidance veers from FASB in a fundamental way by not distinguishing between operating and finance leases.
It is surprisingly closer to that of the International Accounting Standards Board’s IFRS 16, Leases in that it uses a single-model approach which looks at all leases as financing agreements.
A short-term lease, under GASB 87, depends completely on the length of the maximum possible non-cancelable lease term. It is the time that matters, not how likely a lessee is to exercise any options to extend the contract.
Short-term leases don’t have to be capitalized on the balance sheet.
Transfer of ownership
If a contract transfers ownership of an asset, then it is considered a purchase on credit by the lessee. The transfer must happen by the end of the contract and can’t include termination options.
This type of lease also does not need to be capitalized on the balance sheet.
All other leases
If a lease doesn’t fall into one of the two above categories, then it is accounted for with the new single-model approach.
GASB also requires a retrospective application for prior years, so entities must restate all financials for the periods presented. If this is impractical, GASB provides a practical expedient, much like the FASB restatement of financials practical expedient.
Governmental entities will need to make the appropriate adjustments for a cumulative effect of applying the new standard for the earliest year presented and must also disclose the reason why it was necessary to elect the practical expedient.
Key Differences Between GASB 87 and FASB 842
In some sectors, like healthcare and higher education, financial statement preparers follow both GASB and FASB lease accounting policies. So it’s helpful for these professionals to not only understand the differences between the current (legacy) GASB guidance and the new, but also to review how GASB 87 differs from FASB 842.
- GASB 87-- using the single-model approach, all leases are considered to be finance leases. And as such, a new ROU asset and related liability must be entered on the balance sheet.
- FASB 842-- still continues to use a two-model approach. Leases are classified as either operating or finance (previously called capital) leases.
- GASB 87-- lease liabilities are to be reported as long-term debt. This could possibly affect debt covenants and debt to equity ratios.
- FASB 842--operating lease obligations are counted as long-term operating payables.
- GASB 87--the amortization expense on the asset and the interest expense on the lease liability are required to be front-loaded on the income statement.
- FASB 842--operating lease expenses are straight-lined.
- GASB 87--lease payments are classified as capital financing outflows.
- FASB 842--lease payments are classified as operating outflows.
Perhaps because GASB began working on its guidance about the time the other two boards were finishing theirs, updates have not been issued, but in August 2019 it released a 47-page implementation guide. It includes questions and answers that help to clarify and elaborate on the requirements of Statement No. 87, Leases.
Do the Differences Matter?
Historically, GASB entities and FASB entities have reported leases similarly, making a distinction between the two classifications of leases. But after the new standards take effect, GASB and FASB reporters will account for operating leases differently from each other.
That difference could matter greatly to financial statement users like municipal bond investors and analysts. Comparing the financial statements of entities who may report under both GASB and FASB may be more complex because of this accounting difference in the models.
Conclusion: Time is Ticking Away
Avoid the mistakes many public companies made by underestimating the challenges of compliance--and the time it takes. GASB 87 financial statement preparers will face many of the same hurdles in their implementation process.
And they have the added element of the fundamental switch from following guidance that mirrored FASB to now following lease accounting policies aligned more with IASB: Changing from a two-model approach to a single-model approach and its three categories of leases.
Although GASB 87 does mandate changes for lessors, we’ve only discussed lease accounting changes from the lessee’s perspective here. As with the nongovernmental sectors, government lessees will find they are more impacted by the new guidance which ultimately seeks to make appearances the same as reality when it comes to balance sheets.
If you have questions about GASB 87 and its implications, our team at AMTdirect has the expertise and experience--over 20 years--you can trust. We’ve helped hundreds of entities implement the new lease accounting standards and have an automated solution built especially for GASB reporters.