While the decision to lease or purchase an asset is not new, the accounting and financial reporting implications of the decision are changing. The Governmental Accounting Standards Board (GASB) issued Statement No. 87, Leases, which outlines new requirements for governmental entities when it comes to lease accounting. GASB 87 is effective for fiscal years beginning after June 15, 2021.
What is GASB 87?
GASB 87 will replace the current operating and capital lease categories with a single model for lease accounting based on the concept that leases are a means to finance the right to use an asset. Under the new rules, a lessee will recognize a lease liability and an intangible asset while the lessor will recognize a lease receivable and a deferred inflow of resources. However, in order to properly implement this standard, there are some key definitions and concepts to understand first.
- Lease – A contract that conveys control of the right to use a non-financial asset (the underlying asset) for a period of time in an exchange or exchange-like transaction. Right to use includes both the right to obtain the present service capacity and the right to determine the nature and manner of use.
- Lease term – Period in which a lessee has a non-cancelable right to use the asset plus periods covered by an option to extend if it is reasonably certain the option will be exercised and periods covered by an option to terminate if it is reasonably certain the option will not be exercised. Note that cancelable periods including those where either party can terminate without permission or both parties have to agree to extend are not included.
In addition to these key definitions, there are some important exceptions or types of contracts that do not qualify for lease accounting under GASB 87. These include contracts for intangible assets, biological assets, inventory, service concession arrangements, supply contracts and leases with a maximum possible term of 12 months or less.
Under the new standard, a lessee will recognize a lease liability equal to the present value of the payments expected to be made for the lease term and an intangible asset equal to the lease liability plus any payments made upfront. The standard does clarify that if the contract provides for variable payments based on performance or usage those are not part of the lease liability and should be expensed as incurred. As payments are made, the lease liability is reduced and interest expense is recognized. The intangible asset is amortized over the shorter of the lease term or the life of the asset. Financial statement disclosures will include a description of the leases, total lease assets recognized (gross and net) and a schedule of future lease payments, including principal and interest.
