Accounting for Leases
Identify, locate, review, assess, and communicate various aspects relevant to agreements, leases, and contracts.
GFOA Advisories identify specific policies and procedures necessary to minimize a government's exposure to potential loss in connection with its financial management activities. It is not to be interpreted as GFOA sanctioning the underlying activity that gives rise to the exposure.
In June 2017, the Governmental Accounting Standards Board (GASB) issued Statement No. 87,Leases. GASB 87 became effective for fiscal years beginning after June 15, 2021, and all reporting periods thereafter. It is important to know that the standard was required to be applied retroactively; preexisting leases were required to be recognized and measured based on the facts and circumstances of the lease on the first day of the first fiscal year for which reporting is done in accordance with GASB 87, not inception of the lease. While the opening net position of governments that had only operating leases in effect upon implementation will generally not be affected (due to offsetting intangible lease assets and lease debt), the increase in reported debt for lessee governments may impact compliance with debt limits, covenants, and statutes. For governments that had capital leases in effect upon implementation, the accounting for the capital lease will need to be “unwound” and leases in accordance with GASB 87 recorded, which may result in the need to restate opening net position in the first year restated or reported in accordance with GASB 87.
Governments may participate in a significant number of leases and the administration of those leases may be decentralized across the organization, making it difficult to determine exactly which leases may be subject to the new accounting and financial reporting requirements. GFOA recommends that governments develop a plan for the implementation of GASB 87 within their organization. The list of key considerations below has been developed to provide guidance.1
- Identify who currently maintains the information on the various leases:
o Administration, or other departments.
o Are all agreements approved in one central location, or decentralized? Review the records for each location in which agreements are approved.
- Look for existing agreements not currently being recognized or disclosed as leases to ensure completeness, such as:
o Rental agreements;
o Searching vendor payments or general ledger charts of accounts;
o Requesting lease reports from lessors to compare with government data; and
o If your governing board is required to approve all leases, then reviewing past board reports may prove beneficial.
- Review the details of each lease contract.
o If the contract has both lease and nonlease components (i.e. maintenance agreements), separate the lease components from the nonlease components, and treat as separate contracts.
o If the contract has multiple underlying assets with different lease terms:
· Treat each underlying asset as a separate component (lessor and lessee) and allocate the contract price to each component based on professional judgment and reasonableness.
· Use the price for each component in the contract, or
· Stand-alone prices for similar assets.
· If unable to determine an allocation, treat as a single-lease unit.
o Determine the interest rate charged by the lessor in the agreement, if known (it may be implicit in the lease). Otherwise, an estimate of the interest rate the lessee would be charged to finance the lease is acceptable.
- Assess all leases greater than twelve months.
o Leases with multi-year contracts have implications on future periods for budgeting purposes. Their information is probably worth knowing, for management purposes.
- Communicate with outside professionals to ensure broad understanding of the change across the enterprise
o Work closely with the government’s independent auditor to provide training to professional staff as the government approaches implementation
o Contact legal counsel and explain the new terms for accounting purposes. Short-term leases (contract term is for twelve months or less, including options to extend) will continue to be reported as an expense of the period.
o Review debt limits (often set in state law), bond indentures, and other contractual limits on debt with legal counsel.
· Reported debt will increase by the present value of the future lease payments.
· It may be necessary to renegotiate contracts and seek legislative changes before the effective date.
o Review laws and contracts, as well as internal policies, that refer to “capital leases”, which will no longer be an accounting term. It is arguable that all, except the twelve month or less leases, will become “capital leases” under the definition, however it is better to change the language than argue for or against the interpretation.
- Communicate the requirements of the Standard with all stakeholders, emphasizing why it is important to obtain information on all agreements, such as:
o Continuing disclosure requirements; and
o Rating agencies.
- Review or establish a capitalization threshold that may be applied to leases.
o Consider using thresholds in line with capital assets for both assets and liabilities.
- Review all lease agreements and consider renegotiating the terms to make them more explicit and easier to understand, for example the length of the agreement, and the interest rate applied to the lease term.
- Review the general ledger to collect all leases that were formerly reported as rent line items or expenses of the period. After reviewing the details of each agreement, determine whether it should be reported as a lease under GASB 87, or continue to be an expense of the period.
o If determined to be reported as a lease, calculate the present value of the lease to be reported.
o Prepare the details of the lease agreement to be included in the notes to the financial statements, including a schedule of future lease payments if the lessee.
1. This list is not intended to serve as a comprehensive list, but rather a listing of key considerations.
- Board approval date: Friday, September 28, 2018