“Just the facts, ma’am.” Sergeant Joe Friday uttered some version of those words in just about every episode of Dragnet. So taking a cue from the iconic detective…
Here’s just the facts about GASB 87.
The Governmental Accounting Standards Board (GASB) issued Statement No. 87, Leases, in June 2017. Like its counterparts in the non-governmental sector, the governing board’s objective was to improve transparency and comparability in the accounting and financial reporting of leases.
In a news release GASB Chairman David A. Vaudt explained, “The Board’s new leasing guidance better aligns the accounting and financial reporting of these arrangements with their economic substance.”
The primary way all three boards aimed to achieve this goal was by moving operating leases to the balance sheet.
Whereas the Financial Accounting Standards Board (FASB) maintained its two-model approach for the classification of leases, the International Accounting Standards Board (IASB) established a single-model approach with IFRS 16, eliminating the operating lease classification. This shift was based on the thinking that all leases are basically financing arrangements for the right to use an underlying asset.
Like IFRS 16, the new lease accounting standard from the GASB uses the single-model approach. This differs from the existing GASB guidance which uses a dual-model approach more closely mirroring FASB 13 (which dates back to 1976 even before the GASB was formed).
Through the years the GASB has issued concept statements that define terms such as asset, lease and liability and has periodically evaluated their standards to determine if they still worked for governments or if updates were called for.
But GASB 87 presents the biggest change to lease accounting for governmental entities.
GASB 87 becomes effective for reporting periods beginning after December 15, 2019. Leases are to be recognized and measured using the facts and circumstances in existence at the beginning of the earliest period of implementation. Lessors, however, do not need to restate the assets underlying existing sales-type or direct financing leases.
The new lease accounting guidance covers lease contracts for non-financial assets like buildings, land, vehicles and heavy equipment. Donated assets and leases for intangible assets such as mineral rights, patents, copyrights and software are excluded, as are leases for biological assets, inventory, assets financed with conduit debt, supply contracts such as for power and water, and service concession agreements.
GASB 87 provides for three accounting treatments: for contracts that meet its definition of a lease, for short-term leases and for contracts that transfer ownership.
Lease--a contract that conveys control of the right to use another entity’s non-financial asset (underlying asset) as specified in the contract for a period of time in an exchange or exchange-like transaction.
Definition break down
Contract refers to the notion of legal enforceability. Interestingly, a contract is not required to be written, but in order to have evidence of the rights and obligations of the parties involved, it really should be.
Control of the right to use means the lessee is given only the right to use the asset, not ownership of the asset itself. The lessor retains some of the benefits and burdens of owning the asset.
Non-financial was added to exclude securities lending and other transactions involving financial instruments that might otherwise meet the definition, but weren’t intended to be covered by the new standard.
Exchange or exchange-like transaction requires that an equal or almost equal value be exchanged between the lessee and lessor. So arrangements where rent is a nominal fee, like $1 per month, would not be considered leases.
Lease Term--the lease term starts with the non-cancelable period in which the lessee has the right to use the underlying asset, plus any periods covered by options to extend if that option is reasonably certain of being exercised and options to terminate if that option is reasonably certain of NOT being exercised.
Definition break down
Reasonably certain implies a higher level of certainty. It is much greater than likely to occur. It’s almost certain to occur.
Short-term Leases--are leases that at the commencement of the lease term have a maximum possible term of 12 months or less. This includes options to extend regardless of how probable those options are to be exercised.
Both lessees and lessors are to recognize payments for a short-term lease as outflows or inflows of resources, respectively, based on the provisions of the contract.
Contracts that Transfer Ownership--any lease contract that transfers the ownership of an asset is considered a sale by the lessor and a purchase on credit by the lessee. To qualify as such, the transfer of ownership to the lessee must occur by the end of the contract and can have no termination options.
Lease Reporting Under GASB 87
Unless a contract is determined to be a short-term lease as defined above or it actually transfers ownership of the underlying asset, lessees will need to recognize a lease asset and a lease liability at the beginning of the lease term.
The lease asset is to be measured at the amount of the initial lease lease liability plus any payments made to the lessor at or before the beginning of the lease term and certain specific direct costs. The asset is to be amortized over either the lease term or the useful life of the underlying asset, whichever is shorter.
The lease liability is to be measured at the present value of payments expected to be made during the lease term minus any lease incentives received. This liability is reduced as payments are made, and an outflow of resources for interest on the obligation should be recognized
For short-term leases, lessee accounting is functionally the same as the accounting for operating leases under FASB 13 with entries required to be recorded only to account for the outflow of resources during each period. No additional disclosures are required for short-term leases.
Government lessors need to recognize a lease receivable and a corresponding deferred inflow of resources at the beginning of the lease term. There are exceptions for short-term leases and leases that transfer ownership of the underlying asset as well as leases of assets held as investments and specific regulated leases such as those between municipal airports and air carriers.
Over the term of the lease, the lease receivable is to be measured at the present value of lease payments expected to be received and interest revenue is to be recognized as payments are received.
Lessors should not de-recognize the asset underlying a lease.
The deferred inflow of resources is to be measured at the value of the lease receivable plus any payments received from the lessee at or before the beginning of the lease term. Revenue is to be recognized and the deferred inflow of resources should be reduced in a systematic manner over the term of the lease.
For lessees, disclosures under GASB 87 will basically be the same as the disclosures for capital leases under the previous guidance, including a general description of leasing arrangements, the total amount of lease assets recognized and a schedule of future lease payments to be made.
Certain lease transactions, such as subleases and sale-leaseback transactions, require separate disclosures.
Lessors are to disclose a general description of their lease arrangements, including the total amount of inflows of resources from leases for the reporting period.
No disclosures are required for short-term leases.
Multiple Components and Contract Combinations
One of the requirements in the new lease accounting that governmental reporting entities will need to take special note of is in the accounting for lease and non-lease components. They will need to be dealt with as separate contracts.
If a single contract includes more than one underlying asset, each underlying asset is to be treated as a separate lease. In doing this, both lessees and lessors should use contract prices for the individual components providing that those prices are reasonable. If prices aren’t available, then a best estimate approach should be used.
If the same parties enter into multiple contracts at or near the same time, those contracts should be considered parts of the same lease agreement and accounted for under the guidance for contracts with more than one component.
Also embedded leases, which are essentially leases within a service agreement need to be evaluated and accounted for.
Lease Modifications and Terminations
Any amendment to a lease is to be considered a modification to that lease unless the lessee’s right to use the asset is reduced. If the right to use is reduced, then the modification is actually considered a partial or full termination of the lease. The lessee accounts for this termination by reducing the carrying values of the lease liability or lease asset. The lessor reduces the lease receivable and deferred inflows of resources. The difference in the carrying amounts is recognized as either a gain or a loss.
For lessees, lease modifications that do not diminish their right to use are to be accounted for by remeasuring the lease liability and adjusting the corresponding lease asset. Lessors are to remeasure the lease receivable and adjust the corresponding deferred inflow of resources.
Subleases and Leaseback Transactions
A sublease is considered a separate transaction in which the lessee becomes the lessor and follows the accounting required for lessors.
Unless a sale-leaseback transaction includes a sale, it is considered a borrowing transaction. The sale and lease parts of the transaction are accounted for separately with any difference between the carrying value of the sold capital asset and its net proceeds are to be reported as deferred inflow or outflow of resources and recognized over the term of the lease.
Lease-leaseback transactions are to be accounted for as net transactions, disclosing the gross amounts of each part.
Conclusion: GASB 87 Implementation Should Start Now
Because the new lease accounting guidance requires that the balance sheet reflect lease assets and lease liabilities that previously have been disclosed only in footnotes, preparing financial statements will take more time and resources than in years past.
The change from a dual-model approach to a single-model demands that governmental entities make a shift in thinking and give extra attention to the evaluation of their contracts.
And with the deadline for compliance quickly approaching, governmental entities should already be taking the necessary steps to implement the new lease accounting standards. These include the following tasks, some of which should be tackled simultaneously.
- Locate all leases and financing agreements
- Assemble a project team
- Create an inventory of all leases
- Evaluate leases to determine if they are sale transactions, short-term leases or leases
- Evaluate the capacity of current accounting systems
- Compare automated software solutions
- Develop accounting policies and procedures
No matter where you are in the process of GASB 87 implementation, the team of experts at AMTdirect can help you navigate the challenges. With over 20 years of experience in lease accounting and lease administration software, we’ll answer your questions and provide insight into the complexities of the process.
And our GASB 87 solution can automate the entire calculation and reporting process, saving you time, effort and expense.