The industry has been talking about GASB for close to a decade now but it is finally here. The new lease standard will add almost all of our leases onto our balance sheets and will be showing lease liability, and the right to use the intangible assets for all leases with a term greater than 12 months.
This standard applies to all entities that follow GASB standards and is effective for periods beginning after June 30, 2021. Therefore, 2022 is the implementation year.
As presented currently, capital leases are on your balance sheet and operating leases and service contracts are not on your balance sheet.
There are several items excluded under the standard:
- Rights to explore for natural resources
- Biological assets (timber)
- Licensing contracts
- Service concession arrangements
- Leases that are non-exchange transactions
- Short-term leases (< 12 months)
- Contracts that transfer ownership
A short-term lease is defined as a lease that, at the commencement of the lease term, has a maximum possible term under the lease contract of 12 months (or less), including any options to extend, regardless of their probability of being exercised. According to this guidance, month-to-month leases typically fall under the definition of a short-term lease.
I recommend you review the 2019-3 implementation guide related to the standard. There are also two additional implementation guides that provide some great examples of leases, lease terms and so on, guides 2020-1 and 2021-1 If you're thinking of a lease specific to your situation and are trying to determine how to account for it, these guides serve as a great resource.
Step 1: Gathering Leases & Contracts
Now that we’ve been refreshed on GASB 87, where do we start for implementation? The ideal starting point is gathering leases and contracts.
Let’s define exactly what constitutes a lease. By definition, a lease is a contract that conveys the 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. Examples of nonfinancial assets include buildings, land, vehicles, and equipment. Any contract that meets this definition should be accounted for under the lease's guidance unless specifically excluded in this Statement.
The key term here is “contract”. It doesn’t matter if your document or agreement says “lease” or if it says “contract”. By this definition, a lease could be embedded inside of a contract.
Establish a Lease Leader/Team & Create a Timeline
Identify a lease leader or even a lease team in your organization to help gather the necessary documentation and establish an implementation timeline. Since we are already in the implementation year, I’m hoping most of you have started to tackle this but if not, the time is now.
Establish Key Contacts
Reach out to your key departments, especially those who typically enter into leases and use assets. Schools/education, budget, purchasing, procurement, information technology, and departments with numerous assets, like public works, public safety, should be made aware of this standard. I suggest your lease team hold meetings with individuals outside of the finance department to help them identify items to look for.
What Information to Gather
The easiest place to start is with existing leases. Determine what capital and operating leases are currently disclosed on the books and which operating leases have been deemed immaterial in the past and are not currently disclosed. Even if they remain immaterial, you need to gather and inventory each one.
Next, start to think outside of the box. Look for documents that may not say lease in the title but specify the use of an asset. These contracts could potentially fall under the standard. When evaluating those contracts, ask yourself, do they specify us using an asset? Do we as an organization have control of that asset? Control meaning, are we receiving benefits by using them?
Finally, review service contracts. Reach out to your IT and procurement teams since they may have a good handle on these already.
Once you’ve created your inventory of known leases and potential leases, consider obtaining information for those subscription-based information technology arrangements (GASB 96). This is going to be effective beginning in fiscal year 2023. As you're gathering leases and contracts, I recommend you speak with IT now and ask their opinion on your subscription-based information technology arrangements.
The biggest concern you’re going to face, and as an auditor this is definitely going to be a chief concern of ours, is determining if all potential leases have been captured.
How do you tackle this issue of completeness? How do you know you've identified everything?
- Department Inquiry
Touch base with each of your departments to compile the most complete and accurate list possible.
- Rental agreements
Review all rental agreements for potential lease verbiage.
- General ledger details
Look for recurring, consistent payments with vendors, monthly payments, quarterly payments.
- Board/Council Minutes
Review the board and council minutes for significant agreements. This can help you to identify contracts on the onset when they’re entered then agreed and approved by your boards.
Another big issue that will be difficult is the notion of embedded leases. What exactly are embedded leases? It is a lease agreement that exists within a contract. It may not have been identified in prior service arrangements, or use the words lease or rent, and there will likely be some judgement required when evaluating these. Ask yourself, do we, as the lessee, have decision-making rights over some type of asset? If you determine yes, then it needs to be included in the leased inventory. Some common sources of embedded leases are agreements that bundle service and a device concurrently with each other. IT arrangements are known to have some of these embedded leases within them, though they may fall under the new standard coming out next year (GASB 96).
Step 2: Reviewing Leases
Once you’ve gathered what you believe to be all your leases and contracts, it’s time to begin the review process. Starting a spreadsheet to capture and organize the key terms for each lease and contract may be a good approach. Key terms include start date, end date, payment terms, discount rate, and interest rate. You’ll also want to include copies of the agreements. Lease software can also serve as a database for your agreements and terms.
Leases vs. Financed Purchases vs. Service Agreements
After you've reviewed those leases and contracts, you need to determine if they are leases or financed purchases. An easy way to determine if it is a financed purchase is if it mentions a title transfer at the end. If the contract has a bargain purchase option, treat is as a lease until that option is exercised.
Properly identifying a service contract can be tricky. Here are some common service contract characteristics that can help you identify them.
- Supplier fulfills obligation by performing during the contract period.
- Performance to date does not benefit customers throughout the remainder of the service period.
- The benefit is obtained only as the supplier performs services.
- The customer is typically only obligated to pay for the services they are provided.
Lease vs. Non-Lease Components
Does the contract itself have lease and non-lease components? Only the components that are integral to the right-to-use an underlying asset are considered lease components. Some examples of non-lease components include maintenance and security services.
Step 3: Internal Policies, Procedures, & Documentation
The materiality consideration comes up a lot, and it is a good question. GASB discusses it in the standard and in the implementation guide. It should be established for your organization and can be based on total assets, total liabilities or individual thresholds for each capital asset. All of these can be a starting place.
The key is obligation. How material is it? What is not on the books? If these are not capitalized, the liability is also not presented. I highly recommend you run these amounts by your auditors. If you have a ballpark figure of what the non-disclosed liability might be, that's an important conversation for you to have.
There have been some questions about individual and combined assets. Interestingly enough, there is a question in the latest implementation guide (2021-1) about thresholds for individual assets versus combining those assets in aggregate. GASB appears to be going in the direction of aggregation. See question 5.1 in the guide.
Review your current internal controls and identify any changes you’ll need to make. There will need to be document approval and review of the agreements, preparation and review of the calculations, and reconciliations to the general ledger. Don’t forget to check for any compliance issues and separation of duties. Document your process to be followed throughout the year.
Step 4: Recording & Transition
If your fiscal year-end is June 30th, the transition date is July 1, 2021. The cumulative effect should be a restatement of beginning net position for the earliest period presented in your annual financial statements. If it's not practical to restate all prior periods, the cumulative effect should be reported as a restatement of net position. The adjustments should be made by gathering all lease information, then calculating what that liability and asset should be as of July 1, 2021.
GASB 87 is a significant standard, which will require significant efforts and information gathering. In evaluating these contracts, plan on 1-2 hours per equipment lease and 2-3 hours per real estate lease.
We are happy to assist you with implementing GASB 87. Our governmental team is prepared to answer technical questions and assist in preparing your reports to ensure compliance. Contact us today.
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