During the webinar, we received some excellent questions that have broad applicability. We’ve addressed them below, and we hope that this information will help you on your path to implementation.
- Does GASB 87 apply to rentals and other similar agreements?
GASB 87 could apply in certain cases where lease terminology is not used. You should analyze whether the agreement meets the GASB 87 definition of a lease, which is a contract that conveys control of the right to use another entity's nonfinancial asset as specified in the contract for a period of time in an exchange or exchange-like transaction (paragraph 4 of Statement 87).
- We lease land from the state and the agreement requires that we pay $1 per year over the 3-year term. Does GASB 87 apply?
This is a great question! We suspect many governments enter into similar dollar only agreements. Remember that GASB defines leases, in part, as an exchange or exchange-like transaction. This does not appear to be an exchange-like transaction as $1 is likely not an approximation of the true value of the right to use the land for a year; therefore, the GASB 87 definition of a lease is not met.
Within the GASB Implementation Guide No. 2019-3, Leases, question 4.1 is very similar to this fact pattern.
- Do lease arrangements between public housing authorities and qualifying tenants meet the GASB 87 definition of a lease?
All agreements that potentially could meet the definition of a lease should be run through the GASB 87 model. There are some exceptions within GASB 87 to certain types of agreements, however. In addition, keep in mind that if the maximum possible lease term is 12 months or less, the lease would be classified as a short-term lease and not subject to the rules of GASB 87 (paragraph 16 of Statement 87).
- We lease open space land for cattle grazing. How does GASB 87 impact this transaction?
You’ll need to determine whether the agreement conveys control of the right to use the land. In particular, consider if it conveys the right to determine the nature and manner of use of the land (paragraph 5 of Statement 87).
- Our lease agreements have annual opt-out options, but typically remain in effect for 5-10 years. Will GASB 87 apply?
While there is an exception within GASB 87 for short-term leases (those with a maximum possible lease term of 12 months of less), in this case, it appears that this exception is not met as, for purposes of determining whether this exception applies, paragraph 16 within Statement 87 tells us to look at the maximum possible term, including options to extend, regardless of their probability of being exercised. Given the maximum possible lease term exceeds 12 months, GASB 87 will apply, unless this type of agreement meets a different exception under the standard.
There are a number of Q&A’s within GASB’s implementation guide that address the determination of the short term lease exception. Check out questions 4.17-4.20 for more information.
- Can we apply a threshold to lease agreements similar to the threshold used to determine whether to capitalize or expense capital purchases?
GASB does a nice job at summarizing the considerations here, within paragraph B99 of Statement 87, which says, “Some stakeholders questioned whether a government would be permitted to set a policy establishing thresholds for capitalization of its leases, similar to those commonly used for capital assets. The Board views capitalization policies as methods to operationalize materiality; that is, those policies allow governments to specify amounts that they consider to be significant, individually or in the aggregate. The Board believes that a policy similar to those that establish capitalization thresholds could be used for leases. However, establishing such a policy is within the province of management and, accordingly, is not addressed in this Statement. The Board noted, however, that the assessment of the significance of liabilities is independent of capitalization policies.”
- Our government leases buildings for conferences and other events. These agreements span several years but for only a few days each year. Does GASB 87 apply?
The GASB addressed a similar question from the lessee perspective in implementation guide question 4.2. The GASB suggests that GASB 87 would apply if the lease agreement gives control of the right to use the building to the lessee for a set number of days each year. The implementation guide goes on to state that the requirement in GASB 87 that the contract be for a period of time does not require uninterrupted usage.
- We lease land from a third party on which we have constructed a cell tower. A private company makes lease payments to us in order to use space on the cell tower. Do we actually have two leases under GASB 87?
You’re thinking along the right lines here! Both agreements will have to be evaluated in relation to the GASB 87 definition and, in particular, whether the contracts convey control of the right to use the asset.
- What would be a reasonable discount rate for a lessee?
If the interest rate cannot be readily determined by the lessee, the lessee’s estimated incremental borrowing rate (an estimate of the interest rate that would be charged for borrowing the lease payment amounts during the lease term) should be used (paragraph 23 of Statement 87).
- How are variable payments based on an inflation index or usage of the asset to be accounted for?
We need to be careful when we talk about the treatment of variable payments, as different types of variable payments require different treatment under the standard. Variable payments that depend on an index or rate (such as CPI) should be included in the measurement of the lease liability, initially measured using the index or rate as of the commencement of the lease term. In addition, variable payments that are fixed in substance should also be included in the initial measurement of the lease liability. On the contrary, the agreement could contain provisions related to variable payments that are based on future performance or usage. Those would not be included in the measurement of the lease liability.
- Our General Fund owns the administration building and two enterprise funds rent office space. Does GASB 87 apply?
GASB 87 does not address this specific situation. This type of arrangement appears to be ‘interfund services provided and used’ which paragraph 112 of GASB 34 instructs us to account for as revenue and expenditures. It doesn’t not appear that GASB 87 should be applied to these arrangements.
- How does a fiscal funding clause (i.e. a clause that allows the lease to be terminated if funding is no longer available) impact the determination of the lease term?
A fiscal funding clause should only factor into the determination of the lease term if it is reasonably certain the clause will be exercised (paragraph 13 of Statement 87).
- From a lessee’s perspective, what would cause differences between the initial measurement of the lease liability and the lease asset?
The initial measurement of the lease asset is equal to the lease liability plus any lease payments made to the lessor at or before the commencement of the lease term, less any lease incentives received from the lessor at or before the commencement of the lease term. Additionally, initial direct costs that are ancillary charges necessary to place the lease asset into service are added to the lease asset (paragraph 30 of Statement 87).
- What does it mean to consider an asset for impairment under GASB 42?
If any of the impairment indicators listed in paragraph 9 of GASB 42 – including physical damage or obsolescence – are present, a lessee may need to reduce the value of the lease asset (paragraph 34 of GASB 87).
- For enterprise funds, should income from leases be reported as operating income?
Paragraph 102 of GASB 34 already requires governments to establish a policy that defines operating revenues and expenses that is appropriate to the nature of the activity being reported and to disclose it along with other significant accounting policies in the footnotes to the financial statements. The first step would be to apply your existing policy to the lease transaction. Also note that unless you are recording lease income for the first time, this determination has likely already been made for your existing leases, but may be worth revisiting.
- If we are not issuing comparative financial statements, do we still have to retrospectively apply GASB 87?
It is still necessary to restate beginning net position as if GASB 87 had been effective at the start of the year (paragraph 93 of Statement 87).
- Could adding liabilities related to lease agreements previously considered operating leases to the statement of net position impact our compliance with debt covenants or statutory debt limits?
Now that most leases will be accounted for as financings, recording them on the balance sheet may impact the determination of debt limitations and could impact certain debt covenants. We recommend reviewing the specific statute or debt language to determine how this accounting standard may impact these items. This is another reason to begin preparing for GASB 87 sooner rather than later!
- For disclosure purposes, do we have to create new footnotes for leases, or can we include the required disclosures in our capital asset footnote?
You have the option to take either approach.
As you continue to think about this new standard and start in on the implementation, please reach out to our experts if you have additional questions or would like to discuss any of these topics further.