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GASB Statement 87, Leases - How to Implement

Defining Lease Under GASB 87

A lease is a contract that transfers the right to use another entity’s asset (the underlying asset) for a specific period of time in an exchange or exchange-like transaction. (A transaction is exchange or exchange-like when each party in the contract receives or gives up essentially equal value.)

Underlying assets include capital assets (land), buildings, vehicles and equipment.

GASB 87 Does Not Apply to:

  • Contracts that transfer ownership of an underlying asset to the lessee by the end of the contract, and have no termination options. These should be reported as a financed purchase of the underlying asset by the lessee, or sale of the asset by the lessor. For example, a lease-purchase contract.

Understanding Lease Terms

Lease terms are determined after a full analysis of the contract, including factors surrounding the contract. Don’t assume that the contract lease term is the same as the standard lease term.

The lease term includes:

  • The noncancelable period;
  • Periods covered by lessee’s or lessor’s option to terminate that you don’t expect them to exercise; and
  • Periods covered by lessee’s or lessor’s option to extend the lease term that you do expect them to exercise.

Note: If you’re reasonably certain the lessee or lessor will exercise a fiscal funding clause, use the date you expect them to exercise the option to determine the end-of-lease term.

Noncancelable Lease Period

The noncancelable period is when neither the lessee nor the lessor can terminate the contract.

Example
A state agency contract with Agnus Industries has a termination clause allowing the tenant the right to cancel after 90 days. The noncancelable period is 90 days.

Early Termination Period

Leases may include an early termination option after 30, 60 or 90 days’ notice. When this option is available, the termination period occurs after the notice timeframe.

Example
A state agency enters into a five-year contract with KD Industrial Company for office space in Wyoming County. After one year, the agency can give 60 days' notice to terminate the lease. The noncancelable period is 14 months. A termination option covers the remaining 46 months. The agency must determine if it is reasonably certain that they won’t exercise this option.

Lease Extension

Leases may contain an option to extend the lease for a set amount of time.

Example
A state agency enters a five-year contract with Ben Sisko Industries for office space. This lease has two four-year renewal options. If the agency decides it’s reasonably certain it will exercise the first extension, but not reasonably certain it will exercise the second, the lease term is nine years.

Use of Underlying Assets

The lease term is when a lessee has a non-cancelable right to use an underlying asset, plus the following periods of coverage (if applicable):

  • Lessee’s option to extend the lease if it’s reasonably certain the lessee will exercise that option.
  • Lessee’s option to terminate the lease if it’s reasonably certain the lessee won’t exercise that option.
  • Lessor’s option to extend the lease if it’s reasonably certain the lessor will exercise that option.
  • Lessor’s option to terminate the lease if it’s reasonably certain the lessor won’t exercise that option.

The lease term excludes cancelable periods, when both the lessee and the lessor can terminate without permission from the other party.

Note: The following are not considered termination options: Provisions that allows for termination of a lease due to (1) purchase of the underlying asset, (2) payment of all sums due, or (3) default on payments.

Examples of Cancelable Periods

  • Rolling, month-to-month lease; or
  • Lease that continues into a holdover period until a new lease is signed.

Fiscal Funding Clause

Fiscal funding or cancellation clauses allow lessees to cancel a lease if the government doesn’t appropriate funds for payments. This typically occurs on an annual basis. A cancellation clause only affects the lease term if it’s reasonably certain the clause will be exercised.

Review all contracts to see if this clause exists. If it does, you must document your determination of reasonably certain or not reasonably certain.

Making a "Reasonably Certain" Determination

Each state agency must apply its circumstances to GASB-required relevant factors to determine if a lease meets the threshold of “reasonably certain.” Relevant factors include:

  • Market-based factors, such as a whether contract terms and conditions for the optional periods are favorable compared with current market rates.
  • Contract-based factors, such as significant economic deterrents, including costs to terminate an existing lease and sign a new one. Types of costs include negotiation costs, relocation costs, abandonment of significant leasehold improvements, costs of identifying another suitable underlying asset, costs associated with returning the underlying asset in a contractually specified condition or to a contractually specified location, or a substantial cancellation penalty.
  • Asset-based factors, such as whether the asset underlying the lease is necessary for providing government services.
  • Government-specific factors, such as the cost or timeliness of the procurement process or the likelihood to appropriate funds based on historical experience.

View a Reasonably Certain template to document your analysis.

GASB 87 Applicable Lease Types

Payable Leases

Payable leases require the State, as lessee, to recognize a lease liability and an intangible right-to-use lease asset.

The State measures lease liability as the present value of payments expected to be made during the lease term and is centrally calculated.

OSC calculates lease liability when agencies provide the following information:

  • Fixed payments;
  • Variable payments that depend on an index or a rate (Consumer Price Index or market interest rate), initially measured using the index or rate at the end of the lease term;
  • Variable payments fixed in substance;
  • Amounts reasonably certain of being required to be paid by the lessee under residual value guarantees;
  • The exercise price of a purchase option if it’s reasonably certain that the lessee will exercise that option;
  • Payments for penalties for lease termination, including:
    • lease terms with an option for the lessee to terminate the lease;
    • fiscal funding clause; or
    • cancellation clause.
  • Lease incentives* receivable from the lessor;
  • Other payments reasonably certain of being required based on an assessment of all relevant factors.

*Lease incentives are (a) payments made to, or on behalf of, the lessee, for which the lessee has a right of offset with its obligation to the lessor, or (b) other concessions granted to the lessee.

OSC calculates the lease asset when agencies provide the following information:

  • Amount of the initial measurement of the lease liability.
  • Lease payments made to the lessor at or before the end of the lease term, less any lease incentives received from the lessor at or before the end of the lease term
  • Initial direct costs that are ancillary charges required to place the lease asset into service. (Examples may include delivery and installations costs.)

Revenue Leases

Revenue leases require the State, as lessor, to recognize a lease receivable and a deferred inflow of resources.

OSC calculates the lease receivable when agencies provide the following information:

  • Fixed payments;
  • Variable payments that depend on an index or a rate (Consumer Price Index or market interest rate), initially measured using the index or rate at the end of the lease term;
  • Variable payments fixed in substance;
  • Residual value guarantee payments fixed in substances; and
  • Lease incentives.

OSC calculates the deferred inflow of resources when agencies provide the following information:

  • Lease payments made to the lessor at or before the end of the lease term, less any lease incentives received from the lessor at or before the end of the lease term.

Subleases

A sublease is a property rental agreement by a tenant to a third-party for a portion of the tenant’s existing lease contract.

Example
A state agency leases a floor in a building in St. Lawrence County from Conklin Inc. and rents a room to another entity. The state agency is then both a lessee and a lessor, and must report both to the Bureau of Financial Reporting and Oil Spill Remediation.

Sale-leasebacks

A sale-leaseback is the sale of a property with an agreement that it will then be leased back. Only a sale transaction qualifies for sale-leaseback accounting.

Example
A state agency sells a piece of property in Hamilton County to KAL Ltd. The sale includes a contractual agreement that the agency will lease the property back from KAL Ltd. The agency must report the lease to the Bureau of Financial Reporting and Oil Spill Remediation.

Lease-leasebacks

A lease-leaseback is the lease of property to a tenant with the agreement that the property will then be leased back from that same party (usually with an asset or service attached).

Example
A state agency owns a piece of land in Saratoga County and leases it to a private company, Yund Inc. The agreement obligates Yund Inc. to build an office and lease it back to the state agency. The agency must report both leases to the Bureau of Financial Reporting and Oil Spill Remediation.

Software as Leases Subject to GASB 87 and Reporting Subscriptions

The GASB 87 Section 8 standard excludes software. However, contracts may contain an embedded lease of physical computer equipment, which is subject to GASB 87.

Example
A state agency in Albany County has a contract with Mezz Ltd. for cloud computing services, which includes the lease of physical servers. GASB 87 applies to the servers and they must be reported to the Bureau of Financial Reporting and Oil Spill Remediation.

Variable Payment Types for Payable and Revenue Leases

  • Fixed in Substance: payments have a minimum payment.
    • Example: A state agency signs a contract with Conklin Printer Supplies. The contract states the agency pays $0.01 a page or $500 a month, whichever is greater. The minimum payment of $500 is a fixed substance payment.
  • Based on an Index or Rate: payments are based on set common rates or an index, such as the Consumer Price Index.
    • Example: A state agency signs a contract with Abigail Inc. for office space in Saratoga County. The rent is $3,000 per month and increases annually with the Consumer Price Index. The variable payments include the $3,000 monthly rent, plus the Consumer Price Index rate as of the lease end-date.
  • Based on Usage or Future Performance: payments that depend on future performance, such as reaching a certain threshold or usage.
    • Example: A state agency signs a contract with Schneible Industries to rent an excavator for $50 per hour. Each excavator rented in the past 10 years was used for over 500 hours per year. A new construction project requires double the amount of excavator work needed over the course of the contract. The variable payment amount to be included in the measurement is $0 since payments are based on disincentives future usage.