What is the Lease Liability under GASB 87?
The present value of the payments that the lessee must (fixed) make over the course of the lease term is the lease liability. It excludes interest and is decreased by any lease incentives.
What is the Corresponding Lease Asset under GASB 87?
The lease asset recognizes an entity’s right to use the underlying asset leased from the lessor. It is not the underlying asset itself — it is an intangible asset that recognizes the lessee’s right to use that asset.
This asset will be equal to the lease liability, plus prepayments, and minus lease incentives.
GASB 87 Lessee Accounting, Step-By-Step
Here is the lessee accounting process, step-by-step, for any leases that fall within GASB 87’s purview:
1. Calculate Lease Liability (Lessee) or Lease Receivable (Lessor)
First, you must calculate the lease liability. Your lease liability is equal to the present value of the payments you must make to the lessor over the lease term.
For that, lessees need to know the lease’s discount rate. This might be stated explicitly in the lease agreement.
However, if it isn’t, the lease may have information sufficient to calculate an implicit rate. This implicit rate will serve as your discount rate.
If the discount rate is not in the lease and it’s not readily or easily determined, you must use an incremental borrowing rate.
2. Determining the Corresponding Lease Asset's Initial Value
To calculate the value of your corresponding lease asset, start by adding any lease payments you make before or at lease inception to the lease liability number from the previous step.
Then, subtract any lease incentives the lessor offers you and add any prepayments made to the lessor
3. Record the Lease Liability and Related Asset
Next, you’ll create the lease by booking an initial journal entry.
Credit the lease liability by its full initial value and debit the corresponding lease asset by its full initial value. Credit the difference as prepaid rent or a similar account if you made any lease payments before or at lease inception.
4. Recognize Payments & Amortization Lease Over Time
As payments are made and time goes by, you must recognize the reduction of the lease liability and the amortization of the lease asset.
When each payment is made, you will recognize the outflow of cash, a decrease in the lease liability, as well as a portion of the payment being attributed to an interest expense.
Amortization of the lease asset must happen in a “systematic and rational” manner. You can use methods like the straight-line method to amortize the asset. Debit amortization expense and credit accumulated amortization by their proper amounts based on your chosen method.
5. Create the Financial Statement Disclosures
You must prepare the following disclosures on your financial statements:
- A general description of the nature of leasing arrangements. This includes the lease basis, terms, and conditions related to any additional variable payments not included in the lease liability, such as those based on your future performance or underlying asset usage.
- Any residual value guarantees (RVGs), along with their terms and conditions, that are not already included in the lease liability.
- Related-party leases.
- Total lease asset amounts and related accumulated amortization. Group these by the major underlying asset categories (like buildings and vehicles), and disclose them separately from other capital assets.
- Total resource outflow totals recognized in the reporting period (but not included in the lease liability’s measurement) for variable and other payments, like RVGs, termination penalties, and lease incentives.
- Principal and interest requirements to maturity for five subsequent fiscal years and in five-year increments thereafter. Show the principal and interest portions separately.
- Any lease commitments from before the lease term’s commencement.
- Losses/portions of losses associated with an impairment. Include impairment losses and any related lease liability change.
Special Cases for Accounting Purposes
Of the three classifications of leases discussed in GASB 87 – short-term leases, contracts that transfer ownership, and all other leases – the first two do not use the GASB 87 lease account procedures outlined above. Additionally, GASB 87 distinguishes that certain leases contain non-lease components that require special treatment.
Here’s how to account for these contract types.
Short-term leases
Any leases with maximum lease terms of 12 months or less, including options to extend — regardless of intent to exercise those options — are considered short-term leases.
Short-term lessee accounting is nearly identical to FASB 13 operating lease accounting. Lease payments are recorded as resource outflows, or expenses, based on the lease contract’s payment provisions.
The lessee recognizes prepayments as assets and future payments to be made as liabilities for rent due.
Contracts that transfer ownership
If a lease agreement transfers the underlying asset to the lessee at the end of the lease term, the contract is called a contract that transfers ownership.
These contracts may be called leases, however, they do not qualify as leases under GASB 87. Instead, the lessee reports the contract as a financed purchase of the underlying asset.
Agreements must contain no termination options to qualify for the treatment described. They may contain fiscal funding or cancelation clauses if both parties are reasonably certain these clauses won’t be exercised.
Contracts with multiple components
GASB-following entities should account for lease and non-lease components as separate contracts.
Some contracts may have multiple underlying assets within the overarching contract. The lessee should account for each one as a separate lease contract if contract prices for each asset are stated.
If contract prices are not stated, they can use professional judgment to determine these prices if other information is available. Otherwise, they should account for any assets that cannot be reasonably determined as a single lease.
Lastly, contracts created with the same counterparty at or near the same time should be treated as one lease.
Exceptions
Additionally, GASB 87 makes exceptions for several lease types:
- Leases of intangible assets: These leases cover assets without physical substance. For example, the rights to explore for oil and gas or software licenses.
- Leases of biological assets: These leases are for assets that are living, such as plants and animals.
- Leases of inventory
- Service concession arrangements: These are excluded from GASB 87 because GASB 60 covers them.
- Leases in which conduit debt finances the underlying asset: These are excluded unless the lessor reports both the debt and the underlying asset.
- Supply contracts: A seller agrees to provide a buyer with a certain amount of specified goods and services. The buyer agrees to exclusively buy this amount from the seller.
- Leases of assets that are investments
- Certain leases subject to external laws, regulations, or legal rulings
The New Lessee Lease Accounting
With GASB 87 in place, lessees must now make sure they correctly account for the lease liability and corresponding lease asset.
You must know how to calculate the lease liability and corresponding lease asset’s values, then book them with a journal entry and amortize that leased asset over time with more journal entries.
You’ll also need to keep the special cases and exceptions in mind because accounting and disclosures for these may differ.
Lease management software like DebtBook can help you effectively manage all of these lease types as well as more easily organize and find your leases beyond compliance.
