Government Accounting Advisor: GASB Issues Guidance on Leases

In June 2017, the GASB issued Statement No. 87, Leases, to improve accounting and financial reporting for governments with leases. It establishes a single approach for reporting leases, which is to say, it removes the distinction between an operating and capital lease and is consistent with the approach taken by the FASB in its recent standard for nongovernmental entities.

GASB Statement No. 87 is based on the premise that leases are essentially financing arrangements for the use of a nonfinancial asset. As such, lessees record an asset representing the right to use an asset for a period of time and a liability for the lease payments. Lessors recognize a lease receivable and a corresponding deferred cash inflow for the lease payments.

Scope and Applicability

GASB Statement No. 87 applies to the financial statements of all state and local governments, both as lessees and lessors. It applies to any contract that meets the definition of a lease as stated in the Statement. However, it does not include contracts for services, unless it contains both a lease component and a service component.

Practical Consideration: The Statement does not apply to leases of the following: intangible assets, biological assets, inventory, service concession contracts, supply contracts, or certain leases with assets financed with outstanding conduit debt.

GASB Statement No. 87 provides guidance for the following aspects of lease transactions:

  • Lease term
  • Short-term leases (12 months or less including options to extend)
  • Contracts that transfer ownership
  • Recognition, measurement, and disclosure
  • Lease incentives
  • Contracts with multiple components and contract combinations
  • Modifications and terminations
  • Subleases
  • Sale-leaseback and lease-leaseback
  • Intra-entity leases
  • Related-party leases

Accounting by the Lessee in a Nutshell

Excluding short-term leases, the initial measurement of the lease liability is equal to the present value of payments expected to be made during the lease term. Payments include fixed payments, variable payments if they are dependent on an index or rate such as CPI, amounts reasonably required under residual value guarantees, the exercise price of reasonably certain purchase options, termination penalties under certain conditions, lease incentives receivable from the lessor, and any other payment reasonably certain of payment. The discount rate should be the rate implicit in the agreement or, if not readily determinable, the lessee’s incremental borrowing rate.

Initial measurement of the lease asset is the sum of the initial lease liability, the lease payments made prior to lease commencement, and the initial direct costs necessary to place the asset in service. The lease asset should be amortized over the shorter of the lease term or the useful life of the underlying asset and reported as amortization expense.

Contract provisions, such as purchase options, rate changes, and other lease conditions during the term of the lease, may impact how the lease is recorded.

In addition, note that there are different rules for financial statements prepared using the current financial resources measurement focus and those financial statements prepared using the economic resources measurement focus.

Disclosure

The following are just some of the disclosures that should be made by lessees for leases other than short-term leases:

  • General description of lease terms
  • Total amount of lease assets and related accumulated amortization (presented separately from other capital assets)
  • Leased assets by major class (presented separately from other capital assets)
  • Variable payments not previously included in the measurement of lease liability
  • Other payments such as residual value guarantees or termination penalties not previously included in the measurement of the lease liability
  • Principal and interest requirements, presented separately, for the lease liability for each of the five subsequent fiscal years and in five-year increments thereafter
  • Commitments before lease term commencement
  • Impairment losses including the components of the loss.

Additional disclosures are required for sublease, sale-leaseback, and lease-leaseback transactions.

Effective Date

GASB Statement No. 87 is effective for reporting periods beginning after December 15, 2019, with earlier application encouraged.