What is GASB 87?
GASB 87 is a new lease accounting standard created by the Governmental Accounting Standards Board for GASB-following entities, such as state and local governments, higher education institutions, and healthcare organizations. It’s replacing several GASB standards, including GASB 13, GASB 38, and GASB 62. It also amends numerous other GASB standards.
However, organizations are required to implement GASB 87 and achieve full compliance with the new standard for fiscal years ending on or after June 30, 2022.
How Has GASB 87 Impacted Lease Accounting?
The primary aim of GASB 87 was to enhance the usefulness and transparency of financial statements for GASB-following organizations, benefiting stakeholders such as municipal bondholders
One of the primary methods it employs is by mandating that GASB organizations recognize an asset and liability (for lessees) or a deferred inflow and receivable (for lessors) for all qualifying leases. This includes leases formerly not visible on the balance sheet, such as operating leases. The statement claims this will increase financial statement comparability between GASB entities.
GASB 87 also streamlines all lease accounting into a single model and adds some financial statement disclosure requirements regarding the reporting entity’s leases.
GASB 87 is retroactive, meaning entities must include active leases from previous years on their balance sheets in compliance with the standard.
Now that we covered the general changes, let’s dive into some particulars.
Lease categories increased from two to three
Leases were previously classified as either operating or capital leases, the latter sometimes referred to as finance leases.
However, the operating lease classification was eliminated because these leases were not reported on the balance sheet. As a result, stakeholders did not have as full a picture of the entity’s leases.
That left only “capital” leases. That said, the “capital lease” terminology was eliminated. GASB 87 recategorized lease types into three categories:
- Short-term leases: Contracts with non-cancelable terms of 12 months or less after accounting for options to extend — regardless of your intent to exercise that option. Lessees and lessors recognize payments as expenses when paid or revenues when received (respectively).
- Contracts that transfer ownership: Contracts that convey ownership of the asset to the lessee before the lease ends. These do not contain termination options. They may contain cancellation or fiscal funding clauses, but parties must be reasonably certain they will not be used.
- All other leases: Any leases that don’t fit into the first two categories fall under the All Other Leases category.
The definition of a lease now includes control of non-financial assets
GASB 87 changed the definition of a lease to the following:
“A lease is defined as a contract that conveys control of the right to use another entity’s nonfinancial asset (the underlying asset) as specified in the contract for a period of time in an exchange or exchange-like transaction.”
As you can see, the definition includes control of a nonfinancial asset, such as a vehicle, building, or piece of machinery.
To have control over the asset, you need to determine if you have both the right and ability to use it. For example, if you have the right and are able to operate a vehicle belonging to another entity, you have control over it. Therefore, you likely have a lease under GASB 87.
Contract combinations and contracts with multiple components
Contracts can have multiple parts that may or may not qualify for a lease. Under GASB 87, entities must account for lease and non-lease portions of a contract as separate contracts.
For example, you enter a contract with a web hosting company. Part of the contract includes hardware you can’t access, while another part contains data storage you have access to and remains on your property.
The latter could be considered a lease, whereas the first component would not be a lease.
If there are multiple underlying assets within a lease contract, each one should be treated as a separate contract in your entity’s accounting, and you should allocate contract prices to individual assets based on reasonable professional judgment.
If there are no prices stated in the lease, you can use your best estimate. However, if this is not possible, you may be allowed to treat many assets as one lease instead of many.
GASB 87 also notes that in some instances, you may have to consider multiple leases as one contract if you enter into them at about the same time with the same counterparty.
Modifying and terminating leases
If either party makes an amendment to a lease contract, this should be treated as a lease modification.
Lessees account for modifications remeasure the lease liability and recalculate the value of the lease asset. On the other side is the lessor, who must remeasure the lease receivable and deferred inflow of resources.
However, the standard makes an exception if the lessee’s right to use the underlying asset decreases. This would be considered a partial or full lease termination, depending on how much the right to use that asset decreases.
Lessees account for lease termination by reducing the lease liability and asset carrying values. The lessor transaction mirrors this — the lessor reduces the carrying value of the lease receivable and deferred inflow of resources.
Any difference should be counted as a gain or loss, according to the standard.
Subleases and leasebacks
GASB 87 requires the lessee to treat a sublease — in which they become a lessor — as a separate transaction from the original lease contract.
The standard also lays out accounting treatments for sale-leaseback and lease-leaseback transactions in the same section.
A sale-leaseback is when an organization sells a capital asset, then leases it back from the new owner. This only occurs if an asset is actually sold in the transaction. If no asset is sold, it is considered borrowing.
If a sale occurs, parties should treat the sale portion as a separate transaction from the lease portion. However, the lessor or lessee should report any difference between the capital asset’s carrying value and the actual net proceeds from the sale as a deferred inflow of resources or outflow of resources, respectively, and recognize those over the lease term.
GASB 87 eliminates GASB 62’s requirement to evaluate leaseback usage when recognizing gains and losses, simplifying this process.
Lease-leasebacks are a bit simpler. Both parties must recognize a net transaction in one of these scenarios. Depending on which side of the transaction’s present value is larger, one party will have a net lease receivable and the other a net lease liability.
Some leases are unaffected
Most leases fall under GASB 87 if they meet the standard’s definition of a lease, but not all of them. The following are excluded from GASB 87:
- Leases of intangible assets: For example, the rights to explore for oil and gas or software licenses.
- 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 is reporting both the debt and the underlying asset.
- Supply contracts
- Leases of assets that are investments
- Certain leases subject to external laws, regulations, or legal rulings
- Leases with mutual termination clauses (without cause)
GASB 87: Fundamentally Changing Government Lease Accounting
Overall, GASB 87 makes several fundamental changes to lease recognition, measurement, and disclosures that increase the number of lease liabilities reported on financial statements.
Implementing the necessary changes to comply with the new standard may take a significant amount of time and resources, but organizations need to do it before June 30, 2022.
