How to Apply GASB Statement 87, Leases
This article originally appeared in the Association of Government Accountants Central Indiana Chapter’s newsletter.
With the issuance of Statement 87, Leases, the Governmental Accounting Standards Board (GASB) created a single approach to the accounting and reporting of leases. As the effective date for this new standard quickly approaches, here’s what state and local governments need to know about how to apply Statement 87.
The new standard is based on the foundational principle that, economically, a lease finances the right to use an underlying asset. As a result, the accounting for leases required by Statement 87 results in a single approach for lessors and lessees that accounts for leases based on that common financing element. The new standard is a significant change from the current approach to accounting for leases, which provided for two classifications of leases, as either operating or capital, with operating leases being reported off the statement of financial position and only disclosed in the footnotes. Under Statement 87, all leasing transactions will be reported on the statement of financial position of both the lessee and lessor.
The first step will be to identify the population of contracts for which the standard applies. The GASB defines a lease as “a contract that conveys control of the right to use another entity’s nonfinancial assets (the underlying asset) as specified in the contract for a period of time in an exchange or exchange-like transaction.” It is important to note that the definition of a lease does not include intangible assets (such as patents and software licenses), biological assets, inventory, service concession arrangements, supply contracts, or assets financed with outstanding conduit debt unless both the asset and the conduit debt are reported by the lessor. In addition, the definition specifies that the contract is “an exchange or exchange-like transaction.” This means that contracts that transfer the right to use an asset for a nominal amount, such as one dollar per year, do not fall within the scope of Statement 87 since they are, in substance, a nonexchange transaction. The standard also excludes the leasing of assets that are investments and certain regulated leases, such as those between a municipal airport and air carriers.
Under Statement 87’s definition of a lease, the contract conveys control of the right to use another entity’s nonfinancial assets. Both of the following criteria must be met to have control of the asset:
- The right to obtain the present service capacity from use of the underlying asset
- The right to determine the nature and manner of use of the underlying asset
It is important to note the control of the asset can be interrupted and still be met.
Next, a governmental entity needs to evaluate the lease term. The lease term includes the noncancelable period of the lease, plus periods that are covered by the lessee’s option to extend the lease, if the option is reasonably certain of being exercised, plus periods covered by a lessor’s option to terminate the lease, if it is reasonably certain of not being exercised. The lease term under Statement 87 excludes periods for which the lessee or the lessor each have the option to terminate or periods where both parties have to agree to extend the lease. If the lease contains any fiscal funding/cancellation clauses, these should be ignored unless it is reasonably certain they will be exercised. The term of the lease should be determined at the start of the lease and would only be reassessed if one or more of the following occur:
- The lessee or lessor elects to exercise an option even though originally it was determined that the option would not be exercised.
- The lessee or lessor elects to not exercise an option even though it was previously determined that the lessee or lessor would exercise that option.
- An event specified in the contract that requires an extension or termination of the lease takes place.
The standard creates three classifications for leases:
- Short-term leases: According to Statement 87, if a lease’s maximum term, under the written terms of the lease (including any options to extend, regardless of their probability of being exercised), is less than 12 months at its inception, it is a short-term lease and is exempt from the accounting changes in the standard. Under Statement 87, short-term leases will continue to be accounted for in a similar manner to previous guidance for operating leases – by recording expense by lessees and recording revenue by lessors based on the payment provisions of the lease contract.
- Contracts that transfer ownership: If the terms of a lease include the transfer of ownership of the underlying asset at the conclusion of the lease, then under Statement 87 the lease would be classified as a contract that transfers ownership. A transaction classified as a contract that transfers ownership should be accounted for as a financed purchase of the underlying asset by the lessee and a sale of the asset by the lessor. A purchase option within a lease does not constitute the transfer of ownership within the context of Statement 87.
- All other leases: Other than those excluded from the guidance, short-term leases, and contracts that transfer ownership, all other leases will be accounted for under a single reporting methodology outlined in more detail in Statement 87.
The majority of leasing arrangements are expected to fall under the “all other leases” classification.
Statement 87’s requirements are to be implemented and effective for fiscal years beginning after June 15, 2021. This means it will be effective for Dec. 31 year-ends for the calendar year ending Dec. 31, 2022, and for June 30 fiscal year-ends for fiscal year ending June 30, 2022. Early adoption is permitted.
Statement 87 needs to be adopted retrospectively by restating financial statements, if practicable, for all prior periods presented. If it is not practical to restate all prior periods presented, then an adjustment would be made to the beginning net position or fund balance for the earliest period restated, and a reason for not restating prior periods would be disclosed. The notes to the financial statements should disclose the nature and impact of the restatement.
The leases should be recognized and measured using the facts and circumstances that existed at the beginning of the period of implementation. Lessors should not restate the assets underlying their existing sales-type or direct-financing leases. Any residual assets for those leases should become the carrying values of the underlying assets.
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