Just When You Lease Expect It--GASB 87 Requires Even Government Accountants to Capitalize Their Leases

Introduction: Just When You Lease Expect It

Mark Twain observed, “Politicians and diapers must be changed often, and for the same reason.” Add an accounting chase to the reasons for changing politicians. While lease capitalization kicked in for publicly traded firms this year and for everybody else in 2023, GASB 87 surprised observers when it decided to require governmental entities to capitalize their leases for reporting periods after December 15, 2019. Let’s see what this means for your local and state government accounting departments.

GASB: FASB’s Twin on the Government Accounting Side

Most people are aware of FASB (Financial Accounting Standards Board) and its responsibility for generally accepted accounting standards (GAAP) for the private sector, but FASB’s lesser known twin is GASB (Government Accounting Standards Board), and it oversees accounting for local and state governments. GASB has been very active the past several years with considerable attention paid to the liability side after years of underreporting of pension liabilities by cities and states, e.g., Chicago and Illinois.

Lease Capitalization: Government Style

FASB’s ASC 842 recognizes both financing leases and operating leases, but International Financial Reporting Standards (IFRS) treats all leases as financing leases under its IFRS 16 lease capitalization principle. GASB decided to keep it simple, so GASB 87 will also handle all leases as financing leases. This difference will distort comparisons, e.g., state universities vs. private colleges, city garbage collectors vs. publicly traded waste haulers, county hospitals vs not-for-profit church-run hospitals, etc. Clearly, investors, lenders, analysts, and regulators will find it harder to compare financial performance and condition reporting from public and private organizations in the same sector.

Financing Lease Accounting: There Can Be Only One

The lessee recognizes both a lease liability and a “right of use” asset on its balance sheet. The lease liability is the present value of the lease payments, and it includes renewal options if the lessee is reasonably certain it will exercise. As the lessee makes payments, it will reduce the liability and incur interest expense. Meanwhile, the asset is amortized over the shorter of the lease term or the asset’s useful life. The lease footnote must include lease descriptions, future lease payment schedules disclosing interest payments, and total gross and net leased assets. The liability’s interest expense and the asset’s amortization are front-loaded rather than straight-lined, as shown in Figure 1 below:

Figure 1. Example of Financing Lease Treatment for a CT Scanner

Note: The slides in Figure 1 and Figure 2 are from the appendix to my GAAP Gap webinar presentation.

The principal & interest payments are akin to a commercial term loan with principal and interest gradually declining as the lease pays down. Generally speaking, a financing lease assumes the lease term and the useful life of the asset are about the same. Operating leases assume the lease term is much shorter than the useful life, e.g., 10-year lease on a 50-year office building, but government accounting for commercial real estate will not be permitted to use operating leases, which are recognized by their level payment structure, similar to a mortgage payment, as depicted in Figure 2’s treatment of Figure 1’s CT Scanner now as an operating lease:

Figure 2. Example of Operating Lease Treatment for CT Scanner

Like FASB’s ASC 842, leases with terms of 12 months or less do not have to be capitalized. GASB also excludes contracts for intangible assets, biological assets, inventory, service concession agreements, supply contracts, and contracts that transfer ownership of the underlying assets.

The additional lease liability may cause some governmental entities to be out of compliance with debt limitations and bond covenants if it has not yet contacted its creditors and lenders to obtain waivers or amendments to their debt agreements.

Implementation: Better Late Than Never?

Mark Twain advised, “The secret of getting ahead is getting started.” If you bank the government sector, you better find out if your clients have started lease cap implementation. Unlike deferrals in lease capitalization granted to privately-held firms—they’re off the hook until 2023—the GASB folks are sticking to their implementation schedule, so GASB 87 is in place. A major factor in slowing down ASC 842 implementation was the lack of lease accounting software to capitalize the lease and calculate the interest, principal, and amortization amounts. The basic information needed for each lease includes the lease term; lease payment amounts and dates; lease option terms including renewals, purchase options, or cancellation options; variable or percentage rent terms if any; and residual guarantee terms. Further, there are additional data needed for lease calculations that may not be available in the contracts themselves, e.g., interest rates, fair market value, useful life of the asset, lease commencement date. Sometimes, the lease commencement date is disclosed in a separate commencement letter, or you have to guess the commencement date from the first payment date.

Many private organizations discovered how hard it was to identify its leases across departments, divisions, subsidiaries, affiliates, and their other operating components. Fortunately, leasing software vendors and lease capitalization consultants are now available to help government accountants through lease cap implementation.

Summary and Closing: Be at Lease with the World?

Avoid this tip from Mark Twain, “Never put off till tomorrow what may be done the day after tomorrow just as well.” Your government borrowers cannot procrastinate, and neither can you. If you lend to governmental entities, you will want to assure yourself that your borrower has taken the appropriate steps to implement GASB 87. Pay special attention to whether the additional liabilities are likely to cause defaults to their existing indebtedness. In case things don’t work out, let’s close out with one last Twain quote, “Buy land. They’re not making it anymore.”

Sources and References

“Get Ready for GASB 87 Lease Accounting,” Visual Lease, www.visuallease.com

Joe Seabik, “A Paradign Shift in Lessee Acounting: an Explanation of the New US Leasing Guidance,” Bloomberg BNA, www.bna.com/corp/index.html#V , 2016.