New Guidance in Accounting for and Reporting Leases
By now you may have heard about the Governmental Accounting Standards Board Statement Number (GASB) 87 — which is simply titled Leases — and which becomes effective January 1, 2020.
The Washington State Auditor’s Office has done a nice job of helping us understand this new standard with coverage in both the BARS Manual and in an article in their Audit Connection newsletter. The Government Finance Officers Association (GFOA) has also provided a detailed Advisory on the topic. Much of this information has been available for a while — but implementation is now just around the corner.
New Lease Types
In summary, the GASB has adopted an approach that aligns pretty closely with the International Accounting Standards Board's IFRS 16 (also titled Leases). It characterizes leases as one of three types: short-term, contracts that transfer ownership, and everything else. Here’s a look at each type.
This lease has the potential length of the maximum possible noncancellable term of 12 months or less. If after considering the effects of potential extensions (regardless of their likelihood of being exercised) the lease agreement specifies a noncancellable term of 12 months or less, the lease is deemed a short-term lease.
Accounting for a short-term lease simply recognizes the revenues received (if the entity is the lessor) or the lease payments made as an expenditure/expense (if the entity is the lessee). There are no balance sheet or debt-related entries, and no additional disclosures are required in the Notes to the Financial Statements.
Contracts that transfer ownership
Lease contracts that transfer ownership are treated as sales of the asset (by the lessor) and a purchase of the asset on credit (by the lessee). This type of lease cannot contain termination options and the underlying contract transfers ownership of the asset to the lessee by the end of the contract. GASB allows contracts to contain fiscal funding or cancellation clauses and be treated as a sale as long as it is reasonably certain the clauses will not be exercised.
All other leases
Any other contract or agreement that conveys a right of use of property in exchange for payment will be characterized much like the former “capital lease” under the prior standard (FASB 13).
Note that the new standard calls for entities to scrutinize their contractual relationships — regardless if they are characterized as a lease or not — to determine if this use of property should fall under the new guidance. As a result, there have been consistent calls for local governments to review their agreements to see if they may have any lease-reporting obligation where none were believed to have existed previously. In many of the articles cited above local government finance officers are encouraged to lead an effort within their agencies to identify and evaluate if the changes would result in expanded reporting on leases beyond our past practices. I found the GFOA’s guidance most closely aligned with the steps that a finance officer might take to perform this review.
Of course, here in Washington we have the opportunity to account for (and report) our financial transactions under a “cash basis” framework. In the BARS manual the State Auditor’s Office discusses the impact of this new guidance on those entities reporting on a cash basis (essentially the lessee reports the lease on the Schedule 9 and the lessors records the revenue in the 34X series revenue accounts).
We’ve been asked about this topic a few times here at MRSC through our “Ask MRSC” service, which prompted this blog article. We routinely advise local governments to develop policies on how they will address different financial topics — and the topic of the new lease standard is no different. (In fact, you can check out our online resources on developing financial policies.)
We focus on policy-making because this approach engenders thoughtful and inclusive exercises that enable the finance officer to frame the issues and related implications while making decisions about how their organization will work through these issues. Much of the guidance on implementing the new lease standard stresses that the finance officer needs to work with others in their organization to achieve a comprehensive approach. Starting that work with the development of a policy on leases, including the accounting and reporting issues, will set a good foundation for success.
We do not have examples of such policies yet. If you are familiar with one (or even have one yourself), please share it with us. In turn, we’ll share these policies through our website as we receive them.
MRSC is a private nonprofit organization serving local governments in Washington State. Eligible government agencies in Washington State may use our free, one-on-one Ask MRSC service to get answers to legal, policy, or financial questions.