GASB 87, Leases: Your implementation questions answered
Organizations around the country are in vastly different stages of implementation of GASB 87, Leases. Some have taken initial steps toward implementation, while others are actively putting a plan in place. As organizations learn more about the impact of this standard, we’re hearing many common questions from our clients. We’ve also received many excellent questions during our recent webinar, GASB 87, Leases: A closer look. Planning for GASB 87 requires significant time and effort. These FAQs can help keep you on track.
1. Our organization’s fiscal year ends on December 31. When is the standard applicable?
The provisions of this statement were originally effective for fiscal years beginning after Dec. 15, 2019, but were extended 18 months with the issuance of GASB Statement No. 95, Postponement of the Effective Date of Certain Authoritative Guidance. With this extension, the first organizations required to report under GASB 87 will be those with June 30, 2022 fiscal year-end dates. Organizations with calendar year-ends will be required to implement effective with their Dec. 31, 2022 year-end.
2. We know a first step is to identify a complete population of agreements to analyze for potential leases under GASB 87. How can we ensure we’ve identified it?
This is a great question, and one that’s critical to a successful implementation. Start by determining whether procurement within your organization is centralized or decentralized, and whether you have specific departments that house or currently track most of the organization’s contracts.
If your organization has a central procurement or contract approval process, you may be able to work with the purchasing or legal departments to get a complete list of active contracts. Alternatively — or perhaps in addition to that — ask all departments in the organization to identify known leases and potential embedded leases. You could also review the minutes of the governing body to identify significant contracts and review current financial statement disclosures for possible leases. We also recommend analyzing cash receipt and disbursement lists for recurring payments that may relate to leases. The right combination of these options should help you obtain a complete population of leases.
3. Does GASB 87 apply to rentals and other similar agreements?
GASB 87 could apply in certain cases where lease terminology isn’t 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).
4. We lease land from the state and the agreement requires that we pay $1 per year over the three-year term. Does GASB 87 apply?
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 doesn’t 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 isn’t met.
Within the GASB Implementation Guide No. 2019-3, Leases, question 4.1 is very similar to this fact pattern.
Ask all departments in the organization to identify known leases and potential embedded leases.
5. Do lease arrangements between public housing authorities and qualifying tenants meet the GASB 87 definition of a lease?
All agreements that could potentially meet the definition of a lease should be run through the GASB 87 model. There are some exceptions within paragraph 8 of 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).
6. 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).
7. 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 or less), in this case, it appears that this exception isn’t met. For the purpose 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&As 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.
8. 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 of 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.”
9. 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 the 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 doesn’t require uninterrupted usage.
10. We lease land from a third party on which we have constructed a cell tower. A private company makes lease payments to us 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.
11. What steps should we take if there isn’t a discount rate stated in the agreement?
For lessees: If an interest rate isn’t contained within the agreement and cannot be readily determined, a lessee can use their estimated incremental borrowing rate, meaning the estimated interest rate the lessee would be charged to borrow funds to make the required lease payments during the lease.
For lessors: If there is no stated discount rate, the lessor should determine whether the rate implicit in the lease can be estimated. The lessor can compare the fair value of the underlying lease asset to the future payments under the agreement to calculate a discount rate. Lessors may also use professional judgment to estimate the discount rate using observable information, such as the lessee’s estimated incremental borrowing rate or published market rates for similar instruments. If it isn’t practical for the lessor to estimate the discount rate using any of those methods, the lessor’s own incremental borrowing rate may be used.
Governments that lease assets from others will now report liabilities for all of their leases, even those previously considered operating leases.
12. 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 wouldn’t be included in the measurement of the lease liability.
13. Our General Fund owns the administration building and two enterprise funds rent office space. Does GASB 87 apply?
GASB 87 doesn’t 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 appear that GASB 87 should be applied to these arrangements.
14. I’m concerned that implementing GASB 87 could lead to noncompliance with debt covenants or debt limits. Am I looking at this the right way?
Whether you remain in compliance or not will depend on your specific circumstances, but this is definitely a concern that entities need to keep in mind. Governments that lease assets from others will now report liabilities for all of their leases, even those previously considered operating leases. State and local laws, debt limitations, and bond covenants could be impacted based on reporting these new liabilities. Organizations should review these various terms and limitations with bond counsel and/or other legal representatives to assess the impact.
15. I can be reasonably certain of the variable payments that will have to be made under a lease agreement. Should I include them in the lease liability?
We can see why you would ask that, given that in most situations, we try to record amounts using the best estimates possible, but that’s not what GASB 87 is instructing us to do here. Variable payments should only be included if they are fixed in substance. So, you could be nearly 100% certain that variable payments will be made, but if they’re truly variable, they should be excluded from the lease liability. Instead, those variable payments will be recorded as expenses as they are incurred.
16. Once GASB 87 has been implemented, the accounting that follows should be pretty easy, right? I already know what my annual journal entries have to be.
Not necessarily. Once you perform your initial GASB 87 analysis, you’ll have to account for new lease agreements going forward. Each year, you’ll also need to consider if there were any events that would trigger the remeasurement of existing leases.
For lessees, the lease liability must be remeasured when one of the following occurs:
- There’s a change in the lease term.
- The likelihood of a residual value guarantee being paid or a purchase option being exercised changes.
- There’s a change in the estimated amounts for payments already included in the lease liability (except for changes in the index or rate use for variable payments).
- There’s a change in the interest rate being charged by the lessor, if that was used as the initial discount rate.
- A contingency is resolved causing variable payments to become fixed for the remainder of the lease term.
Lessors should remeasure the lease receivable when there are changes to a lease or interest rates, and when contingencies involving variable payments are resolved.
17. 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).
18. 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’s reasonably certain the clause will be exercised (paragraph 13 of Statement 87).
19. 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).
Each year, you’ll also need to consider if there were any events that would trigger the remeasurement of existing leases.
20. 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’re recording lease income for the first time, this determination has likely already been made for your existing leases, but may be worth revisiting.
21. Do the lessor and lessee have to work together on these calculations? Or will there be instances where different amounts are recorded on the lessee and lessor statements?
There is no requirement in GAAP that the two parties have to collaborate on the accounting. Therefore, it’s possible the two parties will arrive at slightly different conclusions regarding the discount rate, the probability of options being exercised, or other assumptions. Each entities’ assumptions will need to be evaluated on their own merits.
22. 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.
23. When budgeting my revenue from leases, can I just assume it will equal the cash payments?
Depending on the level of precision needed for your budget, that may be a reasonable approximation, but remember that the revenue won’t be recognized on a cash basis. Lessors have two revenue components from leases: interest income and lease revenue. Since interest income is a function of the discount rate and the lease receivable, the interest is higher in the earlier periods and goes down over time (like a mortgage). Meanwhile, the deferred inflows of resources recorded at the beginning of the lease are required to be amortized in a “systematic and rational manner” (per paragraph 54 of GASB 87). This guidance is subject to interpretation, but most organizations will likely opt to use a straight-line approach. This is why revenue recognition won’t necessarily equate to cash received.
24. If we aren’t issuing comparative financial statements, do we still have to retrospectively apply GASB 87?
It’s still necessary to restate the beginning net position as if GASB 87 had been effective at the start of the year (paragraph 93 of Statement 87).
25. What tools or other assistance do you recommend with the implementation?
We recommend that organizations first determine the potential impact of the lease standard. Understanding the population of leases that need to be analyzed is a good starting point. Those organizations with smaller numbers of agreements to be analyzed might be able to keep the work in-house, whereas other organizations with a large number of agreements may need to reach out for some extra assistance.
To help analyze and track the leases, some organizations may elect to purchase some type of lease software. Others may have access to a free tool or decide to perform their own calculations using an excel-based tool or template.
If you haven’t done so already, start preparing now. Implementing GASB 87 will require a lot of your organization’s time and effort. 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.