What is the impact of Governmental Accounting Standards Board (GASB) 87?
GASB 87 brings all long-term leases (those longer than 12 months) onto the statements of net position of governmental entities. This stands to have a large impact on financial reporting for governments that participate in leases either as a lessee or lessor.
The new Standard goes into effect for calendar year ending December 31, 2020 and fiscal years ending in 2021. While governmental entities still have time to implement the standard, there are important steps that should be started as soon as possible. Doing the prep work now can make the transition to full implementation go a lot smoother.
GASB 87: Important Implementation Steps
- Create an inventory of all leases. At large, decentralized governments it is possible that many leases could exist that the financial reporting group is unaware of. It is important to take steps to identify all leases that exist. This requires timely and thorough communication with all departments that could have leases. Keeping track of lease inventory can be done in an Excel spreadsheet or, if the number of leases warrants, new software may be needed.
- Identify the elements of each lease that will impact financial reporting.
- Lease Term – The lease term should include the noncancelable period of the lease plus the following events, if reasonably certain these events will occur: (1) periods covered by the option to extend (lessee or lessor), (2) periods covered by the option to terminate (lessee or lessor), or (3) fiscal funding or cancellation clause.
- Interest rate – The interest rate should be the rate included in the lease contract or an implicit rate if the rate is not stated. If it is not practical for the lessee to calculate an implicit rate, then they have the option to use their incremental borrowing rate.
- Fixed and Variable Payments – The inventory should summarize all payments to be made or received under the lease. This includes variable payments from the events that were determined to be reasonably certain to occur that effect the lease term.
- Develop a process to receive updates at least annually from departments that manage leases. Lease liabilities and receivables will need to be remeasured if events occur that change the lease term or change the expected cash flows under the lease. Therefore, it is important to constantly update the lease inventory to reflect these changes.
Governments that are lessees will need to record a lease liability and a lease asset, as well as add significant footnote disclosures. The lease liability will be measured at the present value of all cash flows expected to be made during the lease term. These cash flows include fixed lease payments, variable payments if based on an index, and variable payments that are fixed in substance. Other payments in the liability calculation include the following (if reasonably certain to be paid during the lease): residual value guarantee payments, purchase options, and termination penalties. The lease liability will be reduced as lease payments are made and the discount rate will be amortized into interest expense.
The offsetting lease asset will be measured as the sum of the lease liability, any payments made before the commencement of the lease term, and any direct costs necessary to place the asset into service. In most cases the initial lease asset will be equal to or larger than the lease liability. The lease asset will be amortized over the shorter of the useful life of the asset or lease term and this amortization expense can be combined with depreciation expense on the face of the financial statements.
In addition to financial reporting changes there disclosures will need to be added to the footnotes, which disclose the description of leasing arrangements, the total amount of lease assets and accumulated amortization (separate from other capital assets), the amount of lease assets by major class (separate from other capital assets), the expense recognized for variable payments that are not part of the lease liability, and principal and interest requirements to maturity. There are also additional disclosures for impairment losses and sublease, sale-leaseback, and lease-leaseback transactions.
Governments that are lessors will need to record a lease receivable, deferred inflow of resources, and add significant footnote disclosures. The lease receivable will be measured at the present value of all cash flows expected to be received during the lease term. These cash flows include fixed lease payments, variable payments based on an index, and residual value guarantee payments that are fixed in substance. The lease receivable will be reduced as lease payments are received and the discount rate will be amortized into interest revenue.
The offsetting deferred inflow of resources will be measured as the sum of the lease receivable and any payments received before commencement of the lease term. The deferred inflows of resources will be recognized as revenue over the term of the lease.
It is important to note that the lessor does not de-recognize the underlying asset associated with the lease. Normally, the lessor will continue to depreciate the underlying asset and evaluate it for impairment. However, if the lease contract requires the lessee to return the asset in its original or enhanced condition, the lessor would not depreciate the asset during the lease term.
In addition to financial reporting changes, disclosures there will need to be added to the footnotes, which disclose the description of leasing arrangements, the total revenue recognized from leases during the year, the amount of revenue from variable payments that are not part of lease receivable, and the existence of options by the lessee to terminate the lease. There are also additional disclosures for leases of assets that are investments, regulated leases, subleases, sale-leaseback, and lease-leaseback transactions.
Exclusions to the Standard
There are certain leases that are excluded from the financial reporting required by GASB 87. These include short-term leases, contracts that transfer ownership, and certain regulated leases.
A short-term lease is defined as a lease with a maximum possible term under the contract of 12 months or less. These could also include rolling month-to-month or year-to-year leases that are cancelable by either the lessee or lessor. For the rolling leases, the maximum possible term is the noncancelable period, including any notice periods. Financial reporting for short-term leases is essentially on the cash basis and payments will be recognized as revenue by the lessor when received and as an expense by the lessee when paid.
Contracts that transfer ownership of the underlying asset to the lessee at the end of the contract period and do not include termination options should not be treated as leases under GASB 87. Instead, these contracts should be treated as a financed purchase by the lessee and a sale of the asset by the lessor.
The exclusion of certain regulated leases could impact any lease that meets the criteria, however it is likely to impact certain leases at airports. Lessors will recognize revenue based on payment provisions for these regulated leases and will not report receivables and deferred inflows of resources on the statement of net position.
A regulated lease is defined as a contract where lease rates cannot exceed an amount determined by an external regulator, lease rates are required to be similar for similar lessees, and the lessor cannot deny lessees the right to lease if facilities are available. Typically, leases at airports that are for aeronautical uses will meet the definition of a regulated lease. Leases at airports that are for nonaeronautical use, such as flight kitchens, reservation/ticket counters, parking, rental cars, ground transportation, and concessionaires; or leases that are not rate regulated by external parties will be reported the same as other leases in GASB 87.
Lessors with one or more regulated leases must disclose the general description of the agreements, the extent to which capital assets are used under the agreements, the total amount of revenue recognized, the schedule of future minimum payments, and the terms and conditions where the lessee could terminate the agreements.
CSH is Here to Help
Whether you want to talk through lease agreements, would like a review of your processes for identifying leases, or need staffing assistance to accumulate the information from leases at your government, CSH can help. Please reach out to Brian Mosier or your current CSH advisor for help with implementing these new accounting requirements.