The new GASB lease accounting standard for governmental organizations, GASB Statement No. 87, Leases, was proposed during 2017 and released in June of 2017. It was initially effective for reporting periods that begin subsequent to December 15, 2019.
In May 2020, the GASB issued Statement No. 95, Postponement of the Effective Dates of Certain Authoritative Guidance, which delayed the GASB 87 effective date by 18 months. This pronouncement now requires the adoption of GASB 87 for all fiscal years that begin subsequent to June 15, 2021. However, the requirement to restate all prior periods presented, if practicable, remains. Due to this requirement, organizations should ensure preparedness to facilitate compliance with GASB 87 requirements for the fiscal year prior to adoption. In addition, the GASB encourages early adoption. If organizations have already developed policies, controls, and efforts surrounding the adoption, it’s highly encouraged to consider adoption based on the original effective date.
The example in this blog will continue to utilize an adoption date in 2020, in support of early adoption advised by the GASB.
While the release of the government lease standard coincides with that of the other new lease accounting standards (ASC 842 and IFRS 16), in terms of timing, and the concept of recording a right-of-use asset and corresponding liability for operating leases, the standards don’t exactly mirror each other.
The definitions of lease and lease term are generally the same between the standards. However, the GASB approach is consistent with IFRS 16 in that the lessee will classify all leases as financing arrangements. Additionally, accounting for short-term leases and contracts that transfer ownership is different between GASB and FASB.
The key differentiator between GASB 87 and the current GASB guidance, including GASB 13 and GASB 62, relates to lease classification and further recognition in the financial statements. Under the current standard, organizations do not reflect operating lease agreements within the Statement of Financial Position.
To more accurately portray lease obligations and thus, increase the usefulness of governmental financial statements, GASB 87 requires all agreements that meet the definition of a lease to be recognized in the financial statements and classified as a finance lease.
The finance lease classification is a similar designation as the capital lease classification under the current GASB standard, just with a fresh nomenclature.
GASB 87 defines the scope of leased assets as non-financial assets, such as land, buildings, equipment, and vehicles. Certain non-financial asset-based lease agreements are out of scope, such as leases of intangible assets, biological assets, and inventory. Other certain agreement types, such as service concession arrangements, supply contracts, and assets financed with outstanding conduit debt fall out-of-scope as well.
Furthermore, there is an exception for short-term leases that have a maximum noncancelable term of 12 months or less, regardless of whether all noncancelable terms are expected to be exercised.
In this detailed example, we will walk through the appropriate accounting for a lease as a lessee in accordance with GASB 87. Here are the lease example details:
- Inception Date: July 1, 2020
- Payment due at Inception: $833.33
- Possession Date: January 1, 2021
- Lease Term: 10 years
- Payments (paid in arrears): $10,000/year
- Annual Escalation: 3%
- Discount Rate: 6.5%
See below for the lease payment schedule in full. All payments noted below are paid in arrears. Note that the total payments for 2021 are $9,167 because we made a prepayment of $833 on the lease inception date, July 1, 2020.
Step 1: Calculate the initial lease liability
The lease liability is calculated as the present value of future lease payments during the lease term.
The lessee accounts for the lease when the organization takes possession of the asset, which represents the date at which the organization has the noncancellable right to use the asset.
In this example, the possession date (and the resulting lease commencement date) is January 1, 2021. Therefore the lessee will only include lease payments made on or after the commencement date in the lease liability calculation. The payment made at lease inception (i.e. July 1, 2020) is not included in the lease liability calculation, but instead is accounted for as a prepayment. The total payments for 2021 are $9,167 because the one month of prepayment from the lease inception date is relieved at lease commencement.
The discount rate utilized, per GASB 87, should be the interest rate implicit within the lease. If that interest rate is not readily determined by the lessee, which occurs in most scenarios, the lessee should use the estimated incremental borrowing rate. The estimated incremental borrowing rate is an estimate of the interest rate that would be charged for borrowing the lease payment amounts during the lease term.
Utilizing the annual discount rate of 6.5%, the present value of future lease payments (calculated using LeaseQuery’s Present Value Calculator) is $80,378.
Step 2: Calculate the initial lease asset value
The lease asset value begins with the amount calculated as the lease liability. In addition to the present value of future lease payments, the asset value would include prepaid lease payments, less any lease incentives received from the lessor prior to the commencement of the lease term.
Based on this information, the lease asset will initially begin at the same value as the lease liability: $80,378. Next, the lessee will add the prepayment amount at inception to the liability value to calculate the full lease asset value. Thus, the initial lease asset value will calculate as $80,378 + 833 = $81,211.
Step 3: Record the opening Journal Entry under GASB 87
The initial journal entry under GASB 87 will establish the asset and liability on the Statement of Financial Position. Below we present the entry that would be recorded as of 1/1/2021.
Step 4: Book subsequent journal entry
The lease asset should be amortized, reported as an outflow of resources, in a “systematic and rational manner” over the lesser of the lease term or useful life of the underlying asset. The Board notes that this amortization expense would represent an outflow synonymous to depreciation expense; thus, we will refer to the finance leased asset amortization expense as depreciation expense.
Subsequent entries will also decrease the lease liability and record interest expense. Periodic interest expense is calculated similarly as interest expense has always been calculated for a capital lease – utilizing the an interest rate multiplied by to determine the expense, based on the ending liability balance of the prior period. The lessee will record interest expense and amortize the lease liability as the difference between the cash payment and the calculated interest expense.
See below for the lease amortization table for this lease asset and lease liability and an example of a subsequent entry:
Utilizing the amounts established in the lease amortization table above, the journal entry for the end of the first period is as follows:
The lessee would continue to record subsequent journal entries using the approach above until the end of the lease term.
We’re compiling GASB 87 articles and resources here to help you get up to speed and keep up with the latest developments. Here are the top five articles that will help you prepare for the effective date of the new standard:
In this article, we provide two full examples for lessees explaining how to transition from the current GASB guidance to statement number 87.
The GASB summary covers the main points of the new guidance, such as the definition of a lease; determining the lease term; and accounting for lease modifications and terminations.
This overview is good for anyone who will be impacted by the new rules but won’t be involved in the day-to-day work of implementing them.
Read a full example of lessor accounting under the new governmental standard.
Learn how to identify leases that may be embedded in contracts.
Read the final Implementation Guide No. 2019-3, Leases, issued by GASB.
Remove all room for doubt with cloud-based lease software for GASB 87 built by accountants
LeaseQuery is dedicated to providing the best-available software for GASB 87. Schedule a demo with us today and see how the system will ensure your compliance with the new standard.
As always, remember to keep an eye on our blog for all of the most important updates and changes to the lease accounting standards, including more guidance and insights on GASB 87.