Authored by Jodi Dobson and Carla Gogin
While the decision to lease or purchase an asset is not new, the accounting and financial reporting implications of the decision are changing. The Governmental Accounting Standards Board (GASB) recently issued Statement No. 87, Leases, which outlines new requirements for governmental entities when it comes to lease accounting.
GASB 87 will replace the current operating and capital lease categories with a single model for lease accounting based on the concept that leases are a means to finance the right to use an asset. Under the new rules, a lessee will recognize a lease liability and an intangible asset while the lessor will recognize a lease receivable and a deferred inflow of resources. However, in order to properly implement this standard, there are some key definitions and concepts to understand first.
Lease – A contract that conveys control of the right to use a non-financial asset (the underlying asset) for a period of time in an exchange or exchange-like transaction. Right to use includes both the right to obtain the present service capacity and the right to determine the nature and manner of use.
Lease term – Period in which a lessee has a non-cancelable right to use the asset plus periods covered by an option to extend if it is reasonably certain the option will be exercised and periods covered by an option to terminate if it is reasonably certain the option will not be exercised. Note that cancelable periods including those where either party can terminate without permission or both parties have to agree to extend are not included.
In addition to these key definitions, there are some important exceptions or types of contracts that do not qualify for lease accounting under this standard. These include contracts for intangible assets, biological assets, inventory, service concession arrangements, supply contracts and leases with a maximum possible term of 12 months or less.
Under the new standard, a lessee will recognize a lease liability equal to the present value of the payments expected to be made for the lease term and an intangible asset equal to the lease liability plus any payments made upfront. The standard does clarify that if the contract provides for variable payments based on performance or usage those are not part of the lease liability and should be expensed as incurred. As payments are made, the lease liability is reduced and interest expense is recognized. The intangible asset is amortized over the shorter of the lease term or the life of the asset. Financial statement disclosures will include a description of the leases, total lease assets recognized (gross and net) and a schedule of future lease payments, including principal and interest.
The accounting for a lessor is complimentary. A lease receivable is established at contract inception equal to the present value of the expected payments over the lease term. As payments are received the lease receivable is reduced and interest revenue is recognized. A deferred inflow is recorded equal to the lease receivable and any payments that are made at the beginning of the lease. This deferred inflow is recognized as revenue in a systematic and rational manner over the life of the lease. The lessor is required to disclose a description of the leasing arrangement, the amount of lease revenue recognized in the current period, any revenue recognized from variable or other payments and certain other circumstances if applicable.
Next steps to facilitate a smooth transition to the new lease accounting include:
- Creating an inventory of potential contracts to evaluate
- Determining which contracts meet the definition of a lease
- Review lease contracts for multiple components, such as multiple asset components and service components
- Identifying any contracts that can be excluded based on an exception or materiality
- Gathering key data from contracts in order to determine the lease term and calculate lease liability/asset or receivable/deferred inflow
- Gather data required for footnote disclosures
While GASB 87 is not effective until reporting periods ending Dec. 15, 2020 and after, now is the time to start planning for implementation.
For more information on this topic, or to learn how Baker Tilly state and local government specialists can help, contact our team.