Government entities have until the end of the year to implement the policies and processes needed to comply with new rules on accounting for leases. The new standard for governmental organizations, GASB Statement No. 87, Leases, was released in June of 2017 and is effective for reporting periods that begin subsequent to December 15, 2019.
While the release of the governmental lease standard coincides with that of the other new 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 the IASB standards in that all leases will be classified as financing arrangements, and the liability is classified as long-term debt. Additionally, accounting for short-term leases and contracts that transfer ownership is different between GASB and FASB.
GASB 87 vs. the current GASB guidance: Key differences
The key differentiator between GASB 87 and the current GASB guidance, including GASB 13, 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.
Scope of the new governmental lease accounting standard
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, inventory, as well as service concession arrangements, supply contracts, and assets financed with outstanding conduit debt.
Furthermore, there is an exception for short-term leases that have a maximum possible term of 12 months or less.
Example: Accounting for a lease under GASB 87 with Excel
In this detailed example, we will walk through the appropriate accounting for a lease in accordance with GASB 87.
Lease example details:
See below for the lease payment schedule in full. All payments noted below are paid in arrears.
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, since the lessee will only consider lease payments made on or after the commencement date, the payment made at lease inception is not included in the lease liability calculation and instead is accounted for as a prepayment.
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 the future lease payments is calculated as $79,600.67.
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: $79,600,67. Plus, 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 $79,600.67 + 833.33 = $80,434.00.
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 a subsequent journal entry
The leased 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 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.
In our example, the organization has determined that it will recognize the lease expense in a straight-line manner over the remaining lease term. See below for a straight-line depreciation table.
The other remaining aspect of the entry is the interest expense calculation. The lessee will amortize the discount on the lease liability—the difference between the gross cash outflow and the amortization of the liability is calculated as interest expense. This expense is calculated similarly as interest expense has always been calculated for a capital lease—utilizing a daily interest rate to determine the expense, based on the ending liability balance of the prior period and the number of days in the current period.
Based on an opening liability balance of $79,600.67 at 1/1/2021, interest expense is calculated as $5,174.96 for the first annual period. See below for more detail on how the lessee should perform this calculation.
The difference between the gross cash payment and the interest expense calculation equals the reduction in the liability for the period.
Thus, the journal entry to post at the end of the 2021 annual period is as follows:
The lessee would continue to record subsequent journal entries using the approach above on an annual period until the end of the lease term.
Four more articles to help you get ready for the GASB 87 effective date
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 four articles we have found to help you prepare for the effective date of the new standard:
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.
The comment period has already passed, but this guide will give you an idea of what the Board’s final recommendation will be.
Take heed to PWC’s warning that the GASB lease standard doesn’t necessarily echo the FASB standard. The summary highlights differences in accounting for lease arrangements classified as operating between GASB and FASB guidance, including accounting for arrangements as a lessor. Read their summary to see why.
The new rules were put in place to enhance transparency around financial reporting, but the Board also had to consider the cost/benefit ratio of implementing them.
This report from the Financial Accounting Foundation offers insight into the GASB’s expectations regarding perceived costs and benefits for government entities and how the new guidance will benefit preparers and users of government financial statements.
Remove all room for doubt with cloud-based lease software for GASB 87 built by accountants
LeaseQuery is dedicated to providing those reporting under GASB 87 with the best available software for lease accounting. 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.