Getting a Jump Start on Implementing GASB Statement 87 – Accounting for Leases
In June 2017, the Governmental Accounting Standards Board (GASB) issued Statement No. 87. The purpose of this statement was to enhance government financial statements by making lease accounting uniform across all governmental entities. Users of the financial statements will now be able to see any lease liability or lease asset on the face of the financials, regardless of its previous classification as either an operating or a capital lease.
This new standard becomes effective for fiscal years beginning after June 15, 2021. Early implementation is recommended, although not required. If you present multiple periods on your financial statements, the prior period is required to be restated. If, for example, you are a calendar year-end and you present comparative information, both your December 31, 2022 (year of implementation) and December 31, 2021 (comparative year) will have to reflect this new standard. Below are three steps we recommend take place soon to ensure a seamless implementation of this new standard.
Steps to Implement GASB 87
- Take inventory of all possible leases. The first step is to review all contracts to determine if they are a lease or not. The GASB 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.” In this new standard, “substance over form” applies; meaning, if it walks, talks, and acts like a lease, it is one. Even though the contract might not say “LEASE” on it, if it presents as a lease of a nonfinancial asset from one entity to another, then it must be considered a lease for GASB 87. Examples of a nonfinancial asset include buildings, land, vehicles, and equipment.
- Determine if the lease is exempt. Once you’ve identified all possible leases, you’ll then want to determine if any of them are exempt from Statement 87. The GASB identifies specific assets that are exempt from implementation including intangible assets, biological assets, and inventory. Short-term leases are also exempt from Statement 87. The definition of a short-term lease is any lease that has a maximum lease term of 12 months or less. The lease term includes any options to extend, regardless of their possibility of being exercised, so if a lease has an option to extend for, say, another 5 year term, it is considered long-term. Additionally, if the asset transfers ownership at the end of the lease, it is exempt from GASB 87. Instead, it should be recognized as a financed purchase of the underlying asset by the lessee or a sale of the asset by the lessor.
- For leases falling under GASB 87, determine the initial lease asset and liability and the corresponding monthly and annual adjustments.
Navigating New Rules for Lessors
For lessors, you will recognize a lease receivable and a deferred inflow of resources at the beginning of the lease. The lease receivable is calculated using the present value of lease payments expected to be received during the lease term. The deferred inflow of resources is measured by adding the lease receivable plus any payments received at or before the commencement of the lease term that relates to future periods (payment for final month’s rent, for example). As the rent is paid each month, the lessor will recognize interest revenue and a reduction of the lease receivable. At the end of the year, the lessor will recognize lease income and a reduction of the deferred inflow of resources.
Navigating New Rules for Lessees
For lessees, you will recognize a lease liability and a lease asset at the beginning of the lease. The lease liability is calculated using the present value of lease payments expected to be made during the lease term. The lease asset is measured by adding the lease liability plus any payments made to the lessor at or before the commencement of the lease term (prepayments, for example) and certain direct costs (insurance, legal, or real estate agent costs, for example). As the rent is paid each month, the lessee will recognize interest expense and a reduction of the lease liability. At the end of the year, the lessee will recognize amortization expense and accumulated amortization related to the lease asset.
Getting an early start on the implementation of GASB Statement 87 will allow for a smooth transition once implementation is required. Questions can be answered, and contracts can be reviewed in detail without the pressure present if you wait until 2022. As always, feel free to contact your AdamsBrown team members with any questions.