With the effective date for Governmental Accounting Standards Board Statement No. 87: Leases (GASB 87) just around the corner, it’s important to reflect on the changes and challenges of implementing this standard and start preparing now. Effective for reporting periods beginning after December 15, 2019, GASB 87 will change accounting for lease arrangements and their presentation in governmental entities’ financial statements. Although GASB 87 also impacts lessors, we will focus on the changes and effects of this standard from the lessee’s perspective.
GASB 87 does away with the concept of capital and operating leases and establishes a single model for lease accounting that treats all leases as financings. This differs from the new lease standard issued by the Financial Accounting Standards Board (FASB), which establishes different accounting requirements for finance and operating leases. GASB 87 defines a lease as “a contract that conveys control of the right to use another entity’s nonfinancial asset (the underlying asset) as specified in the contract for a period of time in an exchange or exchange-like transaction.” At lease commencement, the lessee will recognize a lease liability and an intangible right-to-use asset:
- The lease liability will be based on the present value of future expected payments during the lease term.
- The lease asset will be measured as the amount of the lease liability plus any payments made to the lessor at or before commencement, and certain direct costs, less any lease incentives.
As payments are made, the lease liability will be reduced, and interest expense will be recognized. The lease asset is to be amortized over the shorter of the lease term or the useful life of the underlying asset.
Key Practice Points and Certain Exceptions
Establishing the Lease Term: GASB 87 defines the lease term as “the period during which a lessee has a noncancelable right to use an underlying asset.” The term is to be extended for the following periods, if applicable:
- Periods covered by a lessee’s or lessor’s option to extend the lease if it is reasonably certain, based on all relevant factors, that the lessee or lessor will exercise their respective option.
- Periods covered by a lessee’s or lessor’s option to terminate the lease if it is reasonably certain, based on all relevant factors, that the lessee or lessor will not exercise their respective option.
GASB believes that the term reasonably certain, is a high threshold requiring professional judgment. Many practitioners believe the reasonably certain threshold may be 80-90%.
Short-Term Leases: GASB 87 defines a short-term lease as “a lease that, at the commencement of the lease term, has a maximum possible term under the lease contract of 12 months (or less), including any options to extend, regardless of their probability of being exercised.” Similar to the way operating leases are currently treated, short-term lease payments should be expensed as incurred.
Immaterial Lease Transactions: GASB 87 specifically states that “the provisions of this Statement need not be applied to immaterial items.” Each entity is responsible for determining which items are considered immaterial. Analysis should support this determination, as well as define the entity’s process for evaluating such leases. The determination should also establish a threshold that defines which lease transactions are small enough to preclude them from the requirements of GASB 87. This threshold should be approved by the entity’s governing body and, if applicable, an entity’s regulators and auditor should also be consulted to ensure they have no issues.
Transition: GASB 87 indicates that “leases should be recognized and measured using the facts and circumstances that existed at the beginning of the period of implementation. If applied to earlier periods, leases should be recognized and measured using the facts and circumstances that existed at the beginning of the earliest period restated.” For comparative financial statements, GASB 87 requires a retrospective application for all periods presented, if practical. GASB believes that reasonable efforts should be made before an entity determines that restatement would be impractical. For existing capital leases, lessees will not need to restate the underlying asset associated with those leases.
The process of accumulating data, reviewing existing agreements, and evaluating the adequacy of existing accounting systems and policies in preparation for the implementation of GASB 87 can be extremely time-consuming. It is important to start now. GASB has published an Implementation Guide to assist in this process.
For more information on GASB 87, or for assistance with any matter involving audit and assurance, business advisory, or tax planning and preparation, contact a PYA executive below at (800) 270-9629.
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