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Government Lessees Beware – How Leases are Accounted for is About to Change

If you are a state or local government agency, a lot is about to change. The Government Accounting Standards Board (GASB) issued new guidance (GASB Statement No. 87, Leases) on June 28, 2017, on how state and local governments must account for and report leases on their financial statements. These rules are meant to align GASB lease accounting standards with the standards imposed by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) for businesses. The Statement increases the usefulness of governments’ financial statements by requiring recognition of certain lease assets and liabilities for leases that were previously classified as operating leases.

What’s Changing

Starting with reporting periods after December 15, 2019 (an earlier application is encouraged), entities that lease nonfinancial assets, such as vehicles, equipment, and buildings, must treat these leases as financings of the right to use an underlying asset. In other words, lease liabilities will be considered as long-term debt and lease payments as capital financing. In general, there will no longer be a difference between operating and capital leases for financial reporting purposes. Furthermore, the operating leases classification will no longer be applicable when these standards are implemented.

The new guidance does not apply to nonexchange transactions such as donated assets. GASB defines nonexchange transactions as ones in which a government gives (or receives) value without directly receiving (or giving) equal value in return. In exchange transactions, each party receives and gives essentially equal values.

These standards also do not apply to leases of intangible assets (patents, software licenses, etc.), certain types of short-term financing arrangements (leases for 12 months or less), financed purchases using conduit debt, and supply contracts.

What Government Lessees Need to Know

To be in compliance with these standards, a lessee must:

  • Recognize a lease liability and a lease asset at the commencement of the lease term
  • Reduce the lease liability as payments are made and recognize an outflow of resources (interest) on the liability
  • Amortize the lease asset in a systematic and rational manner over the shorter of the lease term or the useful life of the underlying asset
  • Disclose certain information related to leasing arrangements in the notes to the financial statements, including a description of the arrangements, the amount of lease assets recognized, and a schedule of future lease payments

The above guidance does not apply to short-term leases or when the lessor transfers ownership of the asset to the lessee. Generally, accounting for short-term leases will be treated as operating leases. The lessee will report the lease expense and the lessor the revenue. Additional guidance is provided on the treatment of short-term leases (including options to extend leases) in GASB Statement No. 87. Contracts that transfer ownership from the lessor to the lessee will be considered capital leases which are treated in the same way as a financed sale of an asset.

Lessees should report the lease liability for a long-term lease at the present value of the payments made during the term of the lease. A lease asset should be recorded as the amount of the lease liability plus any payments made to the lessor at or before the commencement of the lease term.

The statements of net position for government agencies will be impacted by these new standards. The GASB’s new rules will generally require that all long-term leases are reported on a lessee’s balance sheet. Many leases that have been classified as operating will have to be considered as long-term assets and non-current liabilities.

There are many other rules in the new standards that you should be aware of and consider, especially on the reporting changes for lessors. The GASB approach and FASB/IASB’s requirements for lessors are different in some situations. Click to read GASB Statement No. 87.

For additional information, contact a member of the LaPorte Public Sector Industry Group.