Factors to Determine if a Lease is Applicable to GASB 87
To come into compliance with GASB 87, you must understand what counts as a GASB 87 lease.
GASB 87 lays out several factors that determine whether a lease falls under the new standard:
Control Over the Right to Use a Physical Asset
The first factor in determining if GASB 87 applies to your lease is whether the lease gives you control over the right to use a physical asset. Physical assets can include, but are not limited to:
- Buildings
- Vehicles
- Machinery
- Land
To establish whether you have control over the right to use the underlying asset, see if the terms of the agreement indicate you can direct how and for what purpose the underlying asset gets used over the specified period.
If the terms do give you this power, determine if you obtain the benefits — the outputs or service potential — of the underlying asset.
If both of these conditions are true, the lease meets the GASB 87 criteria of providing you with control over the right to use a physical asset.
For example, imagine an entity provides you with a vehicle to use for your organization’s purposes while they maintain ownership of the vehicle. In this scenario, you can direct how and for what purpose this vehicle is used while lent to you. Additionally, you obtain the benefits of transportation this vehicle offers.
Therefore, you have control over the right to use a physical asset.
A contract that does not specifically state it is a lease could still be considered a lease under GASB 87, based on the standard’s definition.
Check your technology service agreements. They often have underlying physical assets housed with the vendor but controlled by you, the lessee.
Exchange or Exchange-Like Transaction
An exchange or exchange-like transaction is a transaction where each party gives to each other and receives from each other some asset of equal or approximately equal value.
If you have control over the right to use a physical asset, and a lease contract’s provisions result in an exchange or exchange-like transaction, you have a lease applicable to GASB 87.
Returning to the car example — if you make regular monthly payments to have access to the vehicle, this is most likely an exchange-like transaction. Therefore, you have a lease.
Now, governmental entities commonly lease land or easements to another party for an annual rent of $1.
This is not an exchange or exchange-like transaction because both parties are not giving up equal or almost equal value. Therefore, these contracts are excluded from lease accounting under GASB 87.
GASB 87 Lease Name Changes
GASB 87 scrapped the operating lease entirely, eliminating the need to distinguish between operating and financing leases. This also means all leases will be reported on the balance sheet.
GASB 87 now sorts contracts into three categories. Not all of them are considered leases:
Short-Term Leases
A short-term lease is any contract with a noncancelable term of 12 months or less after accounting for extension options — regardless of whether you don’t intend to use those renewal options.
Lessees and lessors should recognize short-term lease payments as expenses when paid or revenues when received (respectively) based on the lease contract’s payment provisions.
If a lease agreement allows both parties to terminate the agreement without cause, this would be classified as a mutual termination clause and a cancellable lease. Cancellable leases are classified in the same manner as short-term leases.
These are not considered leases under GASB 87.
Contracts that Transfer Ownership
These contracts transfer ownership of the underlying asset before the end of the lease and do not contain termination options. If they contain a fiscal funding or cancellation clause, it is reasonably certain that the clause will not be used. These contracts are considered financed.
A contract with a termination option cannot be a contract that transfers ownership, even if you do not intend to exercise the termination option.
These are not considered leases under GASB 87.
All Other Leases
Any contracts not within the above categories fall under a single model called All Other Leases.
These should be considered a lease that must comply with all of the applicable requirements of GASB 87.
GASB 87 Exclusions
Despite the All Other Leases category, GASB 87 has several specific exclusions exempting certain contracts from compliance.
Service Contracts in Certain Circumstances
GASB 87 specifically excludes service contracts unless those contracts include both a lease component and a service component.
For example, imagine that a County enters into a website hosting agreement that includes website access and data storage.
The contract states that website access does not include access to hardware or any other system resources. The lack of an underlying asset means this portion of the contract is not a lease.
However, the contract also states the data storage is maintained on a server considered County property and for the County’s exclusive use.
That type of language indicates the County can control the manner and use of the underlying asset (the server) and obtain the present service capacity of the server. This meets both of the GASB 87 factors discussed earlier. Therefore, this portion of the contract is a lease under GASB 87
Other Specific Exclusions
GASB 87 contains a list of contract types expressly excluded from the standard's requirements. They are as follows:
- Leases of intangible assets: For example, the rights to explore for oil and gas.
- Leases of biological assets: For example, plants and animals.
- Leases of inventory
- Service concession arrangements (See GASB Statement No. 60)
- Leases in which the underlying asset is financed with outstanding conduit debt unless the lessor reports both the debt and the underlying asset.
- Supply contracts
Summary Questions for Lease Determination
Answering these questions can help you determine if your lease falls under the lease accounting standards for GASB 87:
- Do you control and obtain the benefits of a physical asset you do not own? For example, if an entity allows you to use a vehicle for your organization’s purposes, but you do not own the vehicle, this standard is met.
- Do the contract provisions require an exchange of equal or almost equal value? For example, $1 rentals do not meet this standard.
- Is the contract for 12 months or less? This could classify the lease as a short-term GASB 87 lease.
- Does the contract transfer ownership of the underlying asset and not contain any termination options?
- Is the contract a type that is expressly excluded from the standard? See the list of exclusions above.
