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GASB 87 - Leases

Focus Area: Leases

GASB 87 Effective for FY 2022

February 11, 2020

Update: July 1, 2020 – updated the effective date based on GASB 95; clarify Other Direct Costs capitalized in lease asset; Added FAQ to Appendix A, page 3 to address questions related to lease software procurement; Added Example 6 to Appendix C to address nuances with short term lease exception

Update: August 2021 – include newly issued implementation guidance since prior update; link to OSC discount rate procedural guidance and statewide accounting policy on leases; update references to Comprehensive Annual Financial Report (Annual Report); add Appendix D, revise Appendix A and Appendix B for newly published information.

Update: June 20, 2022 – update references to Annual Comprehensive Financial Report (ACFR); added guidance on contract combinations; update Appendices A and B to clarify guidance related to contracts that transfer ownership and correct links; update Appendix A to add agreements that may contain embedded leases; update Appendix D for new allowance accounts; add Appendix E.

In June 2017, the Governmental Accounting Standards Board (GASB) issued GASB Statement No. 87, Leases. This statement supersedes or amends parts of 15 existing statements. GASB 87 overhauls the accounting and financial reporting of leases for state and local governments by establishing a single model for lease accounting based on the foundational principle that leases are financings of the right to use an underlying nonfinancial asset.

The objective of this statement is to improve the consistency of accounting and reporting for leases by requiring recognition of certain lease assets and liabilities for leases that previously were classified as operating leases. Under the new standard, leases previously classified as capital leases will be impacted also. GASB 87 will enhance the comparability, relevance, and reliability of information about the leasing activities of governments.

GASB 87 was originally effective for the fiscal year ending June 30, 2021. However, in May 2020, GASB issued GASB Statement No. 95, Postponement of the Effective Dates of Certain Authoritative Guidance (GASB 95). Based on the issuance of GASB 95, the implementation of GASB 87 is being delayed to the fiscal year ending June 30, 2022. GASB 87 will require a restatement of beginning balances for all periods presented (retroactive application). This statement will apply to all state and local governments with leasing arrangements as defined in the statement. This standard will have a significant impact on the entire State of North Carolina financial reporting entity, including the primary government (state agencies/departments) and its component units (universities, community colleges, other component units). The requirements in GASB 87 need not be applied to immaterial items.

Identifying Leases and Determining the Lease Term

Under pre-GASB 87 guidance, governments distinguished between operating and capital leases. Beginning in fiscal year 2022 and for all prior periods presented, there is no longer a distinction between operating and capital leases. All leasing arrangements as defined by GASB 87 will now be treated as financings of the right to use the leased asset.

GASB 87 defines a lease as a contract that conveys control of the right to use another entity’s nonfinancial asset (the underlying asset, such as a vehicle, building, or equipment) as specified in the contract for a period of time in an exchange or exchange-like transaction. The contract must be legally enforceable. A contract conveys control of the right to use the underlying asset if it has both of the following:

  1. The right to obtain the present service capacity from use of the underlying asset as specified in the contract and
  2. The right to determine the nature and manner of use of the underlying asset specified in the contract.

Contracts for services are excluded, and contracts that contain both a lease component and a service component should separate and report only the lease component. There are several other exclusions from the scope of this definition. See the list of exclusions in Appendix A, Glossary of Useful Terms and Appendix B, Question 1c.

For further guidance on identifying leases, refer to Appendix A: OSC Steps to Identifying Leases and Appendix B: OSC Decision Guide for Lease Identification. Also refer to questions 4.1 – 4.11 in Implementation Guide No. 2019-3, Leases, for examples and common considerations related to the scope and applicability of GASB 87.

For arrangements that meet the GASB 87 definition of a lease, entities will be required to determine the lease term applicable to that lease, whether the entity is a lessee or a lessor in the arrangement. The lease term is the noncancelable period, plus periods covered by the lessee’s and lessor’s options to:

  • Extend the lease, if reasonably certain of being exercised
  • Terminate the lease, if reasonably certain of NOT being exercised

Periods for which both the lessee and lessor have an option to terminate or both parties have to agree to extend the lease are cancelable periods and are excluded from the lease term. Fiscal funding/cancelation clauses are ignored unless reasonably certain of being exercised.

A lessee or a lessor is ‘reasonably certain’ if they have evaluated relevant factors such as economic incentives or disincentives (cost to terminate, market rates for new leases, cancellation penalties, etc.), the history of exercising options to extend or terminate, and how essential the leased asset is to a government’s operations. After evaluating these factors, an entity can be reasonably certain if there is a greater than probable chance that one of the above options will or will not be exercised. In certain cases, lease terms should be reassessed. For example, if a lessee exercises an option that it was previously uncertain about, the lease term should be adjusted.

GASB 87 specifically exempts short-term leases from the provisions of the standard. A short-term lease is one that has a maximum possible term under the contract, including options to extend, of 12 months or less as determined at the beginning of the lease. Options to terminate the lease are excluded. A short-term lease should be accounted for as expenses for the lessee upon payment and revenues for the lessor upon receipt of the payment, similarly to how operating leases were recognized under previous guidance.

For examples of lease term determinations, see Appendix C: Lease Term Examples. Also refer to questions 4.12 – 4.20 in Implementation Guide No. 2019-3, Leases, for further guidance and clarification.

General Reporting Requirements - Lessee

A government can be either a lessee or a lessor in a leasing arrangement. In this section, we discuss the general reporting requirements for lessees.

One major change that will affect both lessees and lessors with existing capital leases is that the lessee will NOT recognize and depreciate the underlying capital asset in the lease. For leases within the scope of GASB 87, a lessee should initially recognize a lease liability and an intangible right to use asset. The intangible right to use asset (lease asset) is a capital asset. The right to use asset is distinct from the underlying asset itself (vehicle, building, etc.), which will continue to be reported on the lessor’s books.

Lessees should measure the lease liability at the present value of future minimum lease payments. Initial measurement of the lease liability should include the following:

  • Fixed payments
  • Variable payments that depend on an index or rate
  • Variable payments that are fixed in substance
  • Payments for residual value guarantees
  • Exercise price of a purchase option if the lessee is reasonably certain to exercise the option
  • Payments for early termination of the lease
  • Lease incentives receivable from the lessor (this decreases the payment)
  • Any other payments that are reasonably expected of being required based on an assessment of all relevant factors.

Variable payments that are dependent on a lessee’s future performance or usage of the underlying asset should not be included in the lease liability. These variable payments should be expensed when the obligation for payment is incurred. However, if any component of these variable payments is fixed, they should be included in the lease liability.

Future lease payments should be discounted using the interest rate the lessor charges the lessee or the implicit rate. If the interest rate is not readily determinable, the lessee’s estimated incremental borrowing rate should be used.

The lease asset should be measured as the sum of the initial lease liability plus prepayments made at or before the commencement of the lease term less lease incentives received plus initial direct costs that are ancillary charges necessary to place the lease asset in service. An example of an initial direct cost that would be capitalized is transportation charges for bringing the asset to its intended location where it will be placed into service. Other initial direct costs include, but are not limited to, legal, administration, or negotiation fees.

Initial recognition will include a restatement of beginning balances in the year of implementation, so entities are required to calculate lease liabilities and assets as of July 1, 2021, in order to comply with GASB 87. Entities will need to examine their existing capital and operating leases to determine whether they will continue to meet the definition of a leasing arrangement under GASB 87. For existing leases that meet the definition, all lease calculations should be made as if the commencement date of the lease is the earliest period presented. For most entities, this will be July 1, 2021.

In subsequent periods, the lessee will amortize the interest (i.e. discount) on the lease liability and report that amount as interest expense. Payments should be allocated first to interest payable and then to the amortization of the lease liability. The lease asset should be amortized over the shorter of the lease term or the useful life of the underlying asset. If a lease contains a purchase option and it is reasonably certain that it will be exercised, the lease asset should be amortized over the useful life of the asset.

Financial statements prepared using the current financial resources measurement focus, i.e., Governmental Funds (General Fund, Special Revenue Funds, Capital Project Funds, and Permanent Funds), should report an expenditure and other financing source in the period the lease is initially recognized. These should be measured in accordance with the requirements for measuring the lease liability. In subsequent periods, payments should be accounted for as principal and interest expenditures. Amortization of interest should not be recognized in the fund level financial statements.

The lease liability should be remeasured if certain changes have occurred at or before the financial reporting date and the changes are expected to significantly affect the amount of the lease liability. Generally, the lease asset should be adjusted by the same amount as the lease liability.

GASB 87 requires notes to the financial statements for lease activities, other than short-term leases as follows:

  1. General description of its leasing arrangements, including (1) the basis, terms, and conditions on which variable payments not included in the measurement of lease liability are determined and (2) the existence, terms, and conditions of residual value guarantees provided by the lessee not included in the measurement of the lease liability
  2. The total amount of lease assets, and the related accumulated depreciation, disclosed separately from other capital assets
  3. The amount of lease assets by major classes of underlying assets, disclosed separately from other capital assets
  4. The amount of expense/expenditure recognized in the reporting period for variable payments and other payments (such as residual value guarantees or termination penalties) not previously included in the measurement of the lease liability
  5. Principal and interest requirements to maturity, presented separately, for the lease liability for each of the five subsequent fiscal years and in five-year increments thereafter
  6. Commitments under leases before the commencement of the lease term
  7. The components of any impairment loss associated with the underlying asset, including the amount of impairment loss and any related change in the lease liability
  8. Additional disclosures are required for lessees that have sublease, sale-leaseback, and/or lease-leaseback transactions. See GASB 87, paragraphs 81, 85, and 87 for further information.

For further clarification, guidance and examples, please refer to questions 4.23 – 4.42 of Implementation Guide No. 2019-3, Leases.

General Reporting Requirements – Lessor

In many ways, the reporting requirements of the lessor are the mirror image of the requirements for lessees.

Lessors should initially recognize a lease receivable and a deferred inflow of resources. Lessors should measure the lease receivable at the present value of lease payments expected to be received, less amounts deemed uncollectible. Initial measurement of the lease receivable should include the following:

  • Fixed payments
  • Variable payments that depend on an index or rate
  • Variable payments that are fixed in substance
  • Residual value guarantee payments that are fixed in substance
  • Any lease incentives payable to the lessee (this decreases the lease receivable)

Variable payments that are dependent on a lessee’s future performance or usage of the underlying asset should not be included in the lease receivable. These variable payments should be recognized as revenue in the period to which those payments relate. However, if any component of these variable payments is fixed, they should be included in the lease receivable.

Future lease payments to be received should be discounted using the interest rate the lessor charges the lessee or the implicit rate.

The deferred inflow of resources should be measured as the sum of the initial lease receivable plus lease payments received at or before the commencement of the lease term that apply to a future period, such as the final month’s rent, less any lease incentives paid to the lessee.

If the underlying asset in a lease is reported as an investment in accordance with GASB Statement No. 72, Fair Value Measurement and Application, the lessor should not apply the recognition and measurement provisions of GASB 87. The note disclosure requirement in GASB 87, paragraph 57d, should be applied. For example, if a lease is entered for the purpose of subleasing solely for profit, GASB Statement 72 would apply and not GASB 87. There are also different requirements for certain regulated leases, such as aviation leases.

Initial recognition will include a restatement of beginning balances in the year of implementation, so entities are required to calculate lease receivables and deferred inflows of resources as of July 1, 2021, in order to comply with GASB 87. Entities will need to examine their existing leases to determine whether they will continue to meet the definition of a leasing arrangement under GASB 87. For existing leases that will continue to meet the definition, all lease calculations should be made as if the commencement date of the lease is the earliest period presented. For most entities, this will be July 1, 2021.

A lessor should not derecognize the asset underlying the lease. The lessor should continue to depreciate the capital asset and continue to apply other applicable guidance.

In subsequent periods, the lessor will amortize the interest (i.e. discount) on the lease receivable and report that amount as a revenue. Interest should be amortized using the effective interest method, per Implementation Guide 2019-3 Question 4.49. Payments received should be allocated first to interest receivable and then to the amortization of the lease receivable. The deferred inflow of resources should be systematically recognized as revenue over the lease term. Financial statements prepared using the current financial resources measurement focus, i.e., Governmental Funds, should recognize the deferred inflow of resources as revenue, if available, systematically over the lease term. Revenue is considered available if it is collected within 31 days after year-end.

The lease receivable should be remeasured if certain changes have occurred at or before the financial reporting date and the changes are expected to significantly affect the amount of the lease receivable. Generally, the deferred inflow of resources should be adjusted by the same amount as the lease receivable.

GASB 87 requires notes to the financial statements for lease activities, other than short-term leases and certain regulated leases as follows:

  1. General description of its leasing arrangements, including the basis, terms, and conditions on which any variable payments not included in the measurement of the lease receivable are determined
  2. The total amount of revenue recognized in the reporting period from leases, if not already displayed separately on the face of the financial statements
  3. The amount of revenue recognized in the reporting period for variable and other payments not previously included in the measurement of the lease receivable, including revenues related to residual value guarantees and termination penalties
  4. The existence, terms, and conditions of options by the lessee to terminate the lease or abate payments if the lessor government has issued debt for which the principal and interest payments are secured by the lease payments
  5. Additional disclosures are required for lessors that have regulated lease, sublease, sale-leaseback, and/or lease-leaseback transactions. See GASB 87 paragraphs 60, 81, 85, and 87 for further detail.

Additional note disclosures are required if a lessor’s principal ongoing operations consist of leasing assets to other entities or if the lessor has regulated leases.

For further clarification, guidance and examples, please refer to questions 4.43 – 4.55 of Implementation Guide No. 2019-3, Leases.

General Reporting Requirements – Other Topics Addressed

GASB 87 discusses several related topics, such as reporting for lease modifications and terminations, subleases, sale-leaseback transactions, lease-leaseback transactions, intra-entity leases, leases between related parties, and more. Below are the topics considered most likely to apply to state entities during the implementation year of this standard:

  • Intra-Entity Leases:
    • Leases between a primary government and its blended component unit should be eliminated at the reporting entity level. If the blended component unit has separately issued financial statements, the blended component unit should report the lease activity in its standalone financial statements.
    • Leases between a primary government and its discretely presented component unit, such as a university or community college, should be reported separately and should not be eliminated.
    • If the underlying asset is fully owned by the State of North Carolina and the “lease” exists for the purpose of reimbursing costs between one state entity and another, the requirements of GASB 87 do not apply. For example, payments made or received for Motor Fleet vehicles do not fall under the definition of a lease per GASB 87.
    • Leases within departments or between agencies in the primary government (e.g. a lease between the Dept. of Administration and the Dept. of Public Safety) do not fall under the definition of a lease per GASB 87. Leases are the right to use a different legal entity’s nonfinancial asset.
  • Contracts with Multiple Components: These are contracts that may contain both a lease and a non-lease component, or those leases that contain multiple underlying assets.
    • Lease and Non-Lease Component – the lease and non-lease component should be accounted for as separate contracts. In cases where there are no stated prices for the separate components (such as leasing a building and also paying for the associated utilities, which can vary in price), lessees and lessors are permitted to determine their best estimate for allocating the contract price to those components. If a best estimate cannot be determined, the lease can be accounted for as a single lease. The accounting for the lease should be based on the primary lease component.
    • Multiple Underlying Assets – contracts for multiple underlying assets with different lease terms should be accounted for as separate contracts.
  • Contract Combinations: Contracts that are entered into at or near the same time with the same counterparty should be considered part of the same contract if either of the following criteria are met:
    • The contracts are negotiated as a package with a single objective.
    • The amount of consideration to be paid in one contract depends on the price or performance of the other contract.
      If multiple contracts are determined to be part of the same contract, that contract should be evaluated in accordance with the guidance for contracts with multiple components.

For further clarification, guidance, and examples, please refer to questions 4.56 - 4.75 of Implementation Guide No. 2019-3, Leases. Link below.

To gain additional understanding of GASB 87, please refer to the following resources:

GASB 87 Implementation Considerations

OSC expects the implementation of this statement to require a significant expenditure of time, effort, and resources for all state entities leading up to the fiscal year 2022 implementation date and thereafter. It is important for state entities to begin the process of identifying, examining, and maintaining their leasing contracts now to comply with reporting requirements for GASB 87. The change in reporting requirements for leases will require entities to examine current reporting for existing and potential leases to determine whether they meet the new requirements of GASB 87.

In an effort to assist state entities with this implementation and to gain an understanding of the nature of leasing arrangements throughout the State to implement further policy, OSC sent the Lease Inventory Template to primary government agencies on May 17, 2019 (link provided above). Primary government agencies were required to submit certain portions of this template to OSC on December 2, 2019 for leases held as of June 30, 2019. This template was provided to component units as a convenience to build a GASB 87-compliant inventory of their leasing arrangements but is not required to be submitted to OSC. ALL entities throughout the State should update and maintain their respective lease inventories on at least an annual basis.

Governmental Funds (General Fund, Special Revenue Funds, Capital Projects Funds, and Permanent Funds).

The lessee will not report the lease liability and lease asset on the Balance Sheet. The liability will be reported in GASB 5200 Long Term Debt Account Group and the lease asset will be reported in the Fixed Asset System. Additionally, the amortization of interest and the intangible asset will not be reported in the Governmental Fund financial statements. Adjustments will be made in the State’s ACFR in the government-wide financial statements. The Statement of Revenues, Expenditures, and Changes in Fund Balances will be impacted as discussed in the lessee section above for Governmental Funds. The lessee will not recognize restatements in the financial statements. The restatement, if applicable, will be reported in the State’s ACFR in the government wide financial statements. The lessor will report the lease receivable and deferred inflow of resources on the Balance Sheet as discussed in the lessor section above. The lessor will recognize restatements in the financial statements, as applicable. Note disclosures will be required for lessees and lessors as noted above. OSC will provide additional reporting information for leases in Governmental Funds.

Proprietary Funds (Enterprise Funds, Internal Service Funds, and Component Units, such as Universities and Community Colleges).

The Statements of Net Position, Statements of Revenues, Expenses, and Changes in Net Position, Statements of Cash Flows, and the Notes to the Financial Statements will be impacted. Restatements of beginning net position also will be required. At a government-wide level, leasing activities within legally separate business-type activities will be eliminated. For example, at the government-wide level, a lease between two universities or a lease between a university and its own component unit would be eliminated for ACFR purposes. Note disclosures will be required for lessees and lessors as noted above. OSC will provide additional information for leases in Proprietary Funds.

Further, entities should review any existing bond/debt covenants, agreements, laws, etc. to ensure continued compliance after the GASB 87 implementation. If the term “capital lease” is used, this will need to be modified. Consider the implications of simply removing the word “capital” as the number of leases that will be reported will increase significantly. Other implementation considerations should include discussions of potential changes to internal controls and processes for identifying, entering into, and reporting leasing arrangements to prevent and detect material misstatements or omissions for standalone and ACFR financial disclosures.

Thank you for your time and attention to this important change. OSC will continue to provide updates as the standard is implemented. Additional implementation guidance will be issued as it is developed for statewide chart of account changes, policy updates, specific journal entry examples for lessees and lessors, interest rates, and other items. Questions regarding this specific update should be directed to your individual OSC analyst.
 

GASB Info

Documents
GASB 87_Appendix A.pdf
GASB 87_Appendix B.pdf
Gasb 87_Appendix C.pdf
GASB 87_Appendix D.pdf
GASB 87_Appendix E.pdf

Effective Fiscal Year

2022