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Lessee accounting for governments: An in-depth look: State and local governments can comply with FASB Statement No. 87 with the help of these practical illustrations.

Following FASB's issuance of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), in 2016, GASB issued Statement No. 87, Leases, in June 2017, to become effective for reporting periods beginning after Dec. 15,2019.

In the United States, lease accounting standards have historically been in alignment for governmental entities and nongovernmental entities. Indeed, under National Council on Governmental Accounting (NCGA) Statement 5, Accounting and Financial Reporting Principles for Lease Agreements of State and Local Governments, governmental units were required to follow the tenets of FASB Statement No. 13, Accounting for Leases.

But when GASB released GASB 87, it broke with that tradition by adopting a standard that more closely resembles the International Accounting Standards Board's IFRS 16, Leases. While FASB ASU Topic 842, Leases, continues to divide leases into the categories of operating and finance leases on meeting any one of five criteria or not, GASB 87 shares with IFRS 16 the notion of a single model that all leases represent financings. As discussed in greater detail below, GASB 87 provides for three accounting treatments: short-term leases, contracts that transfer ownership, and contracts that do not transfer ownership--a catchall for all remaining leases of nonfinancial assets.

Without the need to distinguish between operating and finance leases, the new GASB standard, like IFRS 16, is somewhat different from Topic 842, while still improving the recognition of leased assets and related liabilities and improving the comparability of financial statements among governmental entities.

SHORT-TERM LEASES

Under GASB 87, the identification of a short-term lease hinges entirely on the length of the maximum possible noncancelable lease term. If the lease agreement specifies a noncancelable term, after considering the effects of potential extensions (regardless of their likelihood of being exercised), of 12 months or less, the lease is deemed a short-term lease.

Lessee accounting for short-term leases is functionally identical to the accounting for operating leases under FASB 13, requiring entries to be posted only to account for the outflow of resources during each period. For governmentwide and proprietary fund financial statements (accounted for using economic resources measurement focus), these payments will be recognized as a rent expense, while for modified accrual fund financial statements, the rent payments will be recorded as expenditures. Short-term leases require no additional disclosures.

CONTRACTS THAT TRANSFER OWNERSHIP

Lease contracts that transfer ownership are treated explicitly as sales of the asset by the lessor and a purchase of the asset on credit by the lessee. These arrangements can transfer ownership in two ways, both requiring the contract to have no termination options. First, the contract can directly specify ownership is transferred at the end of the life of the lease. Alternatively, the contract can implicitly allow the borrower to continue to hold the property to the end of its life by setting up a fiscal funding or cancellation clause (which only activates if the governmental entity does not provide a provision for the payment of the lease obligation) that is reasonably certain not to be exercised.

ALL OTHER LEASES

All leases that do not fall into the two categories listed above are treated with the new single-model approach. Lessees will be required to concurrently recognize a right-of-use asset (reported as an expenditure on modified accrual fund financials, like a capital asset purchase) and the related lease liability (other financing source on modified accrual fund financials). The lease liability, as was standard under FASB 13, will be measured at the present value of effectively fixed minimum lease payments, while the asset's initial balance will equal the liability plus additional payments for initial direct costs made to the lessor on or before the start of the lease term. As the right-of-use asset is classified as an intangible, lessees will be required to amortize the value of the asset in a systematic manner over the shorter period of the lease term or the useful life of the asset. Consistent with the lease liability's treatment as a financing, lessees will also recognize interest expense (expenditures on modified accrual fund financials) over time based on the current balance of the lease and the implicit interest rate charged to the lessee.

Lessee disclosures under the GASB 87 single-model approach will be functionally similar to the disclosures required of lessees with capital leases under the FASB 13 requirements, including a description of leasing arrangements, a summary of lease assets'historical cost and accumulated amortization by type of asset, and a delineation of principal and interest payments required over each of the next five years and beyond, grouped in five-year increments. Special lease transactions, such as subleases and sale-leaseback transactions, will require separate disclosures.

RETROSPECTIVE APPLICATION

Retrospective application is required for prior years under GASB 87 by restating financial statements for all periods presented, unless it would be impractical to do so, as in the case where the required information could no longer be obtained. For example, prior-period information about expired contracts might be unavailable from a lessor that no longer exists. Therefore, in cases where full restatement is not practicable, GASB 87 provides a practical expedient. Under this expedient, governments should adjust fund net position, fund balance, or beginning net position, where appropriate, for the cumulative effect of applying the new statement for the earliest year presented on the financial statements. If a lessee government claims that full restatement is not practicable, it must disclose the reason.

ILLUSTRATIONS

The illustrations in the tables with this article demonstrate the basics of how lessees will be required to account for short-term and long-term ownership transferring and non-ownership-transferring leases and how to present them on their financial statements under GASB 87.

Table 1 illustrates a short-term lease, including the calculations and required journal entries under both accrual and modified accrual accounting.

Table 2 illustrates a long-term (non-ownership-transferring) lease for Pike Township, including the present value calculations and an amortization table. Large organizations with adequate budgets can purchase sophisticated leasing software to automatically calculate the present value of future lease payments. Organizations too small to afford such software can either obtain the present value of an annuity of future lease payments using free calculators available on websites (e.g., the Investopedia present value calculator available at tinyurl. com/y2gepagu) or calculate it using the Excel PV function, entered as =PV(interest rate, number of periods, payment amount, future or residual value, payment time end of period=0 or beginning of period =1). A final option is to obtain the appropriate present value factor from annuity tables provided in most accounting and finance textbooks and multiply it by the annual lease payment.

The Excel PV formula displayed in Table 2 contains a few subtleties. First, the lease payment amount of $10,000 must be entered as a negative number because it represents a cash outflow. The next element in the formula is zero, indicating the lessee receives no future or residual value. If so, it would be entered as a positive number to represent a future inflow. The final element in the formula is zero, indicating this is an ordinary annuity where payments occur at the end of each period. If payments were made at the beginning of each period (an annuity due), the final element in the formula would be 1.

The Excel ROUND function is useful with the PV function because it rounds a number to a specified number of digits. It is entered as =ROUND(the number you want to round, the number of digits to which to round). Table 2 shows how these two functions can be nested together. To avoid decimals in the amortization table in Table 2, all formulas used the ROUND function with the number of digits set to zero.

Table 3 shows the journal entries required by the illustration in Table 2.

For comparison with Table 2, Table 4 illustrates a long-term ownership-transferring lease.

Table 5 presents the journal entries for both accrual accounting and modified accrual accounting for Pike Township based on the illustration in Table 4.

Tables 6 and 7 display the presentation of lease accounts on the lessee governmentwide statement of net assets and statement of activities, assuming the same facts as in Tables 1,2, and 3. For the statement of net assets, the right-of-use asset is presented similarly to other intangibles, with a delineation of the gross amount, the accumulated amortization, and the net amount. The lease liability is split between current liabilities and long-term liabilities.

The statement of activities in Table 7 has three accounts: rent expense on the short-term lease from Table 1, amortization expense on the right-of-use asset from Table 2, and interest expense on the lease liability from Table 2. Each is an operating expense.

In the governmental funds balance sheet, there are no lines specific to lease accounting, as the short-term lease is treated as an expenditure for rent, while the long-term non-ownership-transferring lease is treated as both an expenditure and an "other financing source." As a result, the only fund financial statement impacted by lease reporting is the "Statement of Revenues, Expenditures, and Changes in Fund Balances," as shown in Table 8.

TRANSITIONING TO THE NEW STANDARD

Starting early is important because governments will need to complete a time-consuming process to be ready for implementation for reporting periods beginning after Dec. 15,2019. First, governments must identify the population of all existing leases and gather the relevant contracts. As part of this effort, government units will have to ensure their financial system's chart of accounts can support recording assets, liabilities, and expenses under the new standard, and that recordkeeping systems can meet the data-gathering demands of identifying all leases and lease terms as well as the appropriate amortization of the resulting balances. Governments must also review lease agreements to create a schedule of key data points (e.g., interest rate, lease term, lease payments, and renewal dates, just to name a few) to ensure that amounts can be properly calculated.

After gathering the data, governments must develop accounting policy statements to outline the process for making specific judgments with a significant impact on the measurement of the right-of-use assets and related obligations, such as the likelihood of exercising an optional lease extension or the likelihood of using a fiscal funding or cancellation clause to terminate a lease early. Once the policies have been developed, governments will have to determine whether it is practicable to retrospectively adjust their financial statements for prior periods or whether they will have to use the practical expedient discussed above and write the additional disclosure statements explaining their rationale.

One survey provides evidence that some government units still have a significant amount of work to do to prepare for implementing the new standard. Cherry Bekaert LLP, in its April 2018 Annual State and Local Government Benchmarking Survey regarding GASB 87 assessments (available at tinyurl.com/y2bzjqbq, slide 48) indicates 22% of authorities, 25% of schools, 41% of municipalities, and 50% of counties surveyed had not yet ascertained whether GASB 87 would impact their financial statements nor begun the process to adjust for the potential effects on the financial statements and footnotes. Lessee governments should keep a close eye on GASB's process for developing implementation guidance for the new standard; the board issued an exposure draft for its implementation guide in February, and a final version is expected to be published by the end of the second quarter in 2019.

Although the new GASB standard on lease accounting differs in a few significant ways from the FASB approach, it still achieves the same goal of improving financial reporting by requiring entities to record long-term leased assets and liabilities on their financial statements that were previously recorded as operating leases, which avoided financial statement presentation. This article illustrates only the basics of lessee accounting under GASB 87, and additional analysis will be required for leases with variable payments, contracts with multiple components, lease modifications, sale-leasebacks, leasebacks, intra-entity leases, and subleases. However, for governments with traditional fixed-term leases, hopefully this article will make the main features of the new standard a little easier to understand and enable a smoother, less stressful transition.

IN BRIEF

* GASB's new lease accounting standard becomes effective for reporting periods beginning after Dec. 15,2019, and provides state and local governments with rules based on the principle that all leases represent financings.

* Under the new standard, accounting for short-term leases requires entries to be posted to account for the outflow of resources during each period. 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.

* Leases that are not short-term and do not transfer ownership are treated with the new single-model approach required by the standard. Lessees will concurrently recognize a right-of-use asset and the related lease liability.

* Retrospective application is required for prior years by restating financial statements for all periods presented unless it would be impractical to do so.

AICPA RESOURCES

Articles

"GASB Issues Proposed Lease Accounting Implementation Guide," JofA, Feb. 28, 2019, tinyurl.com/y2ruzmth

"GASB Establishes New Approach for Reporting Leases," JofA, June 28,2017, tinyurl.com/y55v75q2

Publication

State and Local Governments --Audit and Accounting Guide (#AAGSLG18P, paperback; #AAGSLG18E, ebook; #WGG-XX, online subscription)

CPE self-study

Governmental Accounting and Auditing Update (#736489, text; #156487, online access)

Conference

Governmental Accounting and Auditing Update, Aug. 12-13, Washington, D.C. (#GAAC)

For more information or to make a purchase or register, visit aicpastore.com or call the Institute at 888-777-7077.

Archived web event

"GASB Leases: What Preparers & Auditors Need to Know to Be Ready for Implementation," audio playback and slides available at tinyurl.com/y4tjq6xl

Governmental Audit Quality Center

The Governmental Audit Quality Center (GAQC) is a firm membership center that helps member firms achieve the highest standards in Yellow Book, not-for-profit, HUD, or government audits through targeted email alerts, resources, and teleconferences. Visit the GAQC at aicpa.org/GAQC.

By Robert L. Paretta, CPA, Ph.D., and James V. Celia, CPA

Robert L. Paretta, CPA, Ph.D., is associate professor of accounting and management information systems at the Alfred Lerner College of Business and Economics at the University of Delaware in Newark, Del. James V. Celia, CPA, M.S., is a student in the Ph.D. program at The Ohio State University.
Table 1: Illustration of lessee accounting for a short-term lease

Pike Township leases a piece of equipment for 12 months
on 1/1/year 1. The equipment has a five-year economic life.
The lease calls for monthly payments of $2,000 at the end of
each month. The lease conveys no ownership at the end of the
lease term, there are no cancellation options, and there are
no potential extensions to the term. Because the lease specifies
a noncancelable term of 12 months or less, with no extension
options that are reasonably certain to be exercised, the lease
will be treated as a short-term lease under GASB 87.

Accrual accounting: The first month's journal entry would be:

1/31/year 1   Rent expense                           2,000
                Cash                                         2,000

              To record the January year 1 rent
              payment under the short-term lease.

Modified accrual accounting: The first month's
journal entry would be:

1/31/year 1   Expenditures: Rent                     2,000
                Cash/vouchers payable                        2,000
                (if paid by other fund)

              To record the January year 1 rent
              expenditure under the short-term
              lease.

Table 2: Illustration of lessee accounting for
a long-term (non-ownership-transferring) lease

Pike Township leases a machine for a noncancelable
term of three years on 1/1/year 1. The machine has a
fair value of $75,000 and a 10-year economic life.
The lease calls for annual lease payments of $10,000
on 12/31 of each year, and the implicit interest rate
known to the township is 5%. The lease conveys no
ownership at the end of the lease term, contains no
purchase option, and requires no guarantee of residual
value. Because the noncancelable lease term extends past
one year, Paragraph 20 of GASB 87 requires the lessee to
recognize a lease liability and an intangible
right-of-use asset.

Present value of the lease
payments: = PV(.05,3,-10000,0,0) = $27,232.4803

Rounded to nearest integer
(zero decimals): = ROUND(PV(.05,3,-10000,0,0),0) = $27,232

Amortization table for the long-term
lease asset and liability

                            Interest
                Lease         rate         Loan
Date           payment         5%      amortization

1/1/year 1
12/31/year 1   $ 10,000   = $ 1,362    +    $ 8,638
12/31/year 2     10,000   =     930    +      9,070
12/31/year 3     10,000   =     476    +      9,524
Totals         $ 30,000   = $ 2,768    +   $ 27,232

                  Balances for the
                  long-term lease:

Date             Asset     Liability

1/1/year 1     $ 27,232     $ 27,232
12/31/year 1     18,155       18,594
12/31/year 2      9,077        9,524
12/31/year 3         --           --
Totals

Per Paragraph 31 of GASB 87, in the case of a nonownership
purchase lease, the asset is amortized straight-line over
the shorter of the lease term (three years) or the useful
life of the asset (10 years) and may be combined with
depreciation expense related to other capital assets.

The liability is amortized annually by the difference
between and the lease payment

Table 3: Journal entries for illustration in Table 2
(non-ownership-transferring) lease

Accrual acccounting: The first year's journal entries would be:

1/1/year 1     Right-of-use asset                  27,232   27,232
                 Lease liability
               To record the right-of-use asset
                 and related liability lease
                 liability

12/31/year 1   Amortization expense:               9,077
               Right-of-use asset
                 Accumulated amortization:         9,077
                 Right-of-use asset
               To record the first year's
               amortization of the right-of-use
               asset equal to one-third of
               the asset value of $27,232
               each year.

12/31/year 1   Lease liability                     8,638
               Interest expense                    1,362
                 Cash                                       10,000
               To record the first payment on
               the long-term lease liability.

Modified accrual accounting: The first year's
journal entries would be:

1/1/year 1     Expenditure: Lease                  27,232   27,232
               right-of-use asset
                 Other financing source:
                 Lease liability
               To record the lease agreement at
               the present value of the minimum
               lease payments.

12/31/year 1   Expenditure: Lease liability        8,638
               Expenditure: Interest               1,362    10,000
                 Cash
               To record the first payment
               on the long-term lease.

Table 4: Illustration of lessee accounting for a long-term
(ownership-transferring) lease

Pike Township leases office equipment with a fair value of
$75,000 for three years on 1/1/year 1. The equipment has a
10-year useful life with no residual value. The lease calls
for three payments of $27,540 on 12/31 of each year, and the
implicit interest rate known to the township is 5%.
The lease conveys ownership to the township at the end of
the lease term. The township intends to use the
leased asset for its entire useful life and depreciates
similar assets using the straight-line method.

Amortization schedule for the lease liability

                Lease        5%      Lease liability
Date           payment    interest       balance

1/1/year 1                              $ 75,000
12/31/year 1   $ 27,540   $ 3,750         51,210
12/31/year 2     27,540     2,560         26,230
12/31/year 3     27,540     1,310           --
Totals         $ 82,620   $ 7,620

Table 5: Journal entries for the illustration in Table 4
(ownership-transferring) lease

Accrual accounting: First year's journal entries would be:

1/1/year 1     Office equipment                    75,000    75,000
                 Lease liability
               To record the purchase of the
               office equipment on credit.

12/31/year 1   Lease liability                     23,790
               Interest expense                     3,750
                 Cash                                        27,540
               To record the annual payment of
               principal and interest on the
               lease-financed purchase.

12/31/year 1   Depreciation expense:                7,500
               Office equipment
                 Accumulated depreciation:                    7,500
                 Office equipment
               To record annual straight-line
               depreciation on the asset over
               its 10 years of expected time
               in service.

Modified accrual accounting: The first year's
journal entries would be

1/1/year 1     Expenditure: Office equipment       75,000
                 Other financing source:                     75,000
                 Lease liability
               To record the purchase of the
               office equipment on credit.

12/31/year 1   Other financing source:             23,790
               Lease liability
               Expenditure: Interest                3,750
                 Cash                                        27,540
               To record the annual payment of
               principal and interest or the
               note-financed purchase.

Note: Depreciation expense is not recognized in
modified accrual accounting financial statements.

Table 6: Statement of net assets presentation for leases
for the long-term (non-ownership-transferring) lease
based on the fact pattern in Tables 2 and 3

Pike Township
Schedule of items appearing on the Statement of Net Assets
12/31/year 1

Property, plant, and equipment:
  Right-of-use asset                                           $ 27,232
  Less: Accumulated amortization: Right-of-use asset              9,077
  Right-of-use asset (net)                                     $ 18,155

Current liabilities:
  Lease liability                                             $ 9,070 *

Long-term liabilities:
Lease liability                                        9,524 ([dagger])

* Lease liability 12/31/year 1,
$18,594, less the noncurrent amount, $9,524.

([dagger]) Lease liability 12/31/year 1,
$18,594, less the current amount, $9,070.

Table 7: Statement of activities presentation
based on the fact patterns in Tables 1,2, and 3

Pike Township
Schedule of items appearing on the Statement of Activities
For the year ended 12/31/year 1

Operating expenses:
  Rent expense                               24,000 *
  Amortization expense: Right-of-use asset      9,077
  Interest expense                              1,362

* $2,000 per month from Table 1 x 12 months = $24,000.

Table 8: Statement of revenues, expenditures, and changes
in fund balances based on the fact patterns in
Tables 1,2, and 3

Pike Township
Schedule of items appearing on the Statement of Revenues,
Expenditures, and Changes in Fund Balances
For the year ended 12/31/year 1

Expenditures:

Expenditure: Lease right-of-use asset      $ 27,232
Expenditure: Lease liability                  8,638
Expenditure: Interest                         1,362
Expenditure: Rent                          24,000 *
Other financing sources:
Other financing source: Lease liability    $ 27,232

* $2,000 per month from Table 1 * 12 months = $24,000.
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Title Annotation:Financial Accounting Standards Board
Author:Paretta, Robert L.; Celia, James V.
Publication:Journal of Accountancy
Date:Aug 1, 2019
Words:3620
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