7.11 Leased Assets
7.11.1 Leased Land, Buildings, Equipment and Other Assets
(Last Modified on November 2, 2022)
GASB Statement No. 87, Leases, is effective for fiscal years beginning after July 1, 2021. A lease is defined as a contract that conveys 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.
There are four main criteria that a contract must have in order to meet the definition of a lease:
1. Control of the Right to Use
In order to determine the control of the right to use, an institution will need to assess whether it has both of the following:
- The right to obtain the present service capacity of the underlying asset
- The right to determine the nature and manner of use of the underlying asset
Please keep in mind that most contracts contain a termination for defaulting or misusing leased assets. This is more of an exception to allow the lessor a protection and should not preclude the determination of the right to use from existing.
2. Nonfinancial Asset
When analyzing the contracts, it is important to remember the purpose of the GASB Statement 87 is to record a liability for the intangible right to use an asset. Examples of nonfinancial assets may include land, buildings, vehicles, and equipment.
3. Period of Time
A lease should be established as the right to use an asset for a period of time. In understanding this concept, if a contract transfers ownership at the end of a lease without an option to terminate this is not a lease because it doesn’t include the right to use the asset for a period of time. In this case, the transfer of ownership would result in a sale of an asset or a financed purchase. Similarly, leases such as permanent land easements, that last indefinitely would not meet the criterion of period of time and therefore, would not be deemed a lease according to GASB Statement 87.
4. Exchange or Exchange-Like
The foundational principle of this standard is that leases are financings. In a lease transaction, a lessee receives the right to use an asset in exchange for the promise to make payments over time. If the transaction is a nonexchange transaction, it would therefore not be deemed a lease. An example of a transaction that may not be deemed a lease as a result of not meeting the exchange or exchange-like criterion would be a land easement that where the payment may be for a nominal charge that is deemed a nonexchange transaction.
Not all leases are subject to GASB Statement 87. The following are excluded from GASB 87 leases:
- Leases of intangible assets
- Leases of biological assets, including timber, living plants, living animals
- Leases of inventory
- Contracts that meet the definition of service concession arrangement
- Leases in which the underlying asset is financed with outstanding conduit debt, unless both the underlying asset and the conduit debt are reported by the lessor.
- Supply contracts
Transfer of Ownership
As discussed earlier, contracts that transfer ownership without a termination option would also be excluded from GASB Statement 87 reporting as a result of not meeting the period of time criterion. These contracts are commonly referred to as financed purchases or finance lease arrangements. For reporting purposes, the liability associated with these agreements are reported as notes and loans payable.
Short-term leases may be excluded from consideration. These transactions will meet all four criterion of the lease definition, however GASB Statement 87 establishes a provisional exception for leases with a maximum possible term of 12 months (or less), including any options to extend, regardless of their probability of being exercised should be excluded from reporting as a lease. For these situations, a lessee would recognize an expense when incurred.
The lease term starts with the noncancelable period plus the periods covered by options to extend the lease, if reasonably certain of being exercised by either the lessee or lessor and the periods covered by options to terminate, if reasonably certain of not be exercised by either the lessee or lessor. The lease term should exclude any cancelable period (such as a rolling month-to month-lease). Fiscal funding clauses and cancellation clauses are generally ignored in determining the lease term unless there is reasonable certainty of those clauses being exercised.
When determining if an option to extend or termination is reasonably certain the following factors that need to be considered:
- Significant economic incentives that are favorable compared with current market rates
- Significant market disincentive, such as cost to terminate and sign a new lease
- History of exercising options to extend or terminate
- The extent to which the asset is essential to the provision of governmental services
7.11.2 Measuring the Lease
(Last Modified on January 9, 2023)
Future Lease Payments
The lease liability should be measured at the present value of payments expected to be made during the lease term. Future lease payment should include the following: fixed payments (less incentives), variable payments based on index rate, variable payments that are in substance fixed, residual value guarantees, purchase options, termination penalties, and any other payments reasonably certain of being exercised.
If a lease is structured to include variable payments based on future performance of the underlying asset, this variable payment should NOT be included in the lease liability calculation.
For example, if a bus lease is structured for payment of $5 per mile with no minimum payment this is deemed a variable payment based on future performance and would be expensed in the period in which the obligation was incurred.
In contrast, if the lease payments were structured at $5 per mile with a minimum payment of $500 per month this would be a variable payment that is in-substance fixed and the $500 per month would be used in determining the liability.
Some lease obligations have executory costs built into the total lease payment. This additional rental payment may include costs such as insurance, maintenance, and taxes but generally are used for repairs and replacements. If the additional rent is for a non-lease component, these payments would not be included in the calculation of the lease obligation/notes loans payable nor the intangible right-to-use asset/capital asset. This payment would be expensed when paid since this is a period cost. If the additional rent is a component of the lease, these payments should be included in the calculation of the liability.
After determining the future lease payments, the institution will need to discount these payments using the interest rate the lessor charges the lessee, which may be the interest rate implicit in the lease. If the interest rate cannot be easily determined, the lessee should use the incremental borrowing rate. Since USG intuitions fall under the state reporting entity, the State of Georgia’s incremental borrowing rate will be used when that rate is necessary. The State of Georgia’s incremental borrowing rate will be provided to the Chief Accounting Officer’s annually, when available.
Measuring Lease Asset
Generally, the lease liability will equal the leased asset. Some exceptions to this may include lease payments made prior to commencement (less incentives received) or when it is necessary to expend funds prior to placing the asset into service (an example may include installing shelving into a building prior to use).
Beginning Balance: Present Value of Future Expected Lease Payments
Plus: Lease payments made prior to commencement
(Less: Lease incentives received)
Plus: Initial direct cost necessary to place asset into service
Leased Asset Balance
Amortization of Leased Asset
A leased asset should be amortized as the shorter of the lease term or useful life of the underlying asset. If the lease contains a purchase option that the lessee has determined is reasonably certain of being exercised, the lease asset should be amortized over the useful life of the underlying asset. Under this circumstance, if the underlying asset is a non-depreciable asset, such as land, the lease asset should not be amortized.
Modifications and Terminations
Amendments to the contract currently in effect may require a re-measurement of the lease liability or leased asset if the modification is deemed significant. An amendment is considered to be a modification of the lease unless the lessee’s right to use the asset decreases. If the right to use the asset decreases, this would be deemed a termination of the lease (may be full or partial) since this would no longer meet the definition of a lease (control of the right to use criterion).
If significant, a change in the following will trigger a re-measurement:
- Lease term
- Likelihood of purchase option
- Likelihood of residual value guarantee being paid
- Estimated amounts for payments already included in the measurement of lease liability – excludes variable rates
- Interest rate the lessor charges the lessee, if used as the initial discount rate
- Contingency upon which variable lease payments are based
Contracts with Multiple Components
A lease may contain multiple components. In such cases, the non-lease part of the contract should be separated from the leased asset in order to accurately reflect the liability and asset that is being used. If there are no stated prices for individual components or the prices stated appear unreasonable it is permissible to account for the component as a single lease.
Possible contracts with multiple components:
- Copiers and toner and paper
- Building lease and utilities and janitorial costs
A lessor will recognize a lease receivable and deferred inflow of resources at the commencement of the lease term using the same measurement of the lease described previously. A lessor should recognize interest revenue on the receivable from the deferred inflows of resources in a systematic and rational manner over the term of the lease.
The lessor should not derecognize the asset underlying the lease. In instances where the lease contract requires the lessee to return the asset to its original condition, the lessor should not depreciate the asset during the lease term.
|Intangible right to use lease asset - value of lease liability plus prepayments and initial direct costs that are ancillary to place asset in use, less incentives
|Present value of future lease payments (include fixed payments, variable payments based on index or rate, reasonably certain residual guarantees, etc.)
|Equal to lease receivable plus any cash received up front that relates to future period
At the start of the lease term, a lessee would recognize a lease liability and an intangible right-to-use lease asset.
- (DR) Lease Asset
- (CR) Lease Liability
- (CR) Cash (possible entry) – for any indirect costs and lease payments made prior to the start of the lease
At the start of the lease term, a lessor would recognize a lease receivable and a deferred inflow of resources.
- (DR) Lease Receivable
- (DR) Cash (possible entry) – for any lease payments received prior to the start of the lease.
- (CR) Deferred Inflow of Resources
|Amortize the intangible lease asset over shorter of useful life or lease term
|Reduce by lease payments (less amount for interest expense)
|Recognize revenue over the lease term in a systematic and rational manner
Lease payments made to the lessor:
- (DR) Lease Liability
- (DR) Interest Expense
- (CR) Cash
Amortize the leased asset over the shorter of the lease term or useful life of the underlying asset:
- (DR) Depreciation Expense
- (CR) Accumulated Depreciation –Leased Asset
Lease payments received from the lessee:
- (DR) Cash
- (CR) Lease Receivable
- (CR) Interest Income
- (DR) Deferred Inflow of Resources – systematic and rational manner
- (CR) – Lease Revenue
Lessor continues to report and, if applicable, depreciate the leased capital asset.
Matching of Payments from Foundation to Institution
Due to the differences in the lease standards for FASB and GASB, matching of lease liability/notes and loans payable amounts reported by the lessee to the lease receivable amounts reported by lessors will likely not agree between institution and foundation and should be reviewed by the institution annually for significant variances as part of the Annual Financial Reporting process.
7.11.3 Lease Resources
(Last Modified on January 9, 2023)
• GASB Statement 87
• GASB Implementation Guide No. 2019-3
• State Accounting Office Lessee/Lease Accounting Policy
• USG Leases Journal Entry Guide
• GeorgiaFIRST Guidance for Leases (see Asset Management job aids)
• Present Value of Lease Payments Calculation Tool
• GASB 87 – Lease Survey
(Last Modified on January 9, 2023)
Cancelable period – Periods for which a lessee and lessor both have an option to extend or terminate.
Commencement Date – The date a lessor makes the underlying asset available for use which may be the same date as the lease execution date.
Contract – An agreement (written or verbal) between two or more parties that creates an enforceable right and obligation.
Contracts that transfer ownership – A contract that transfers ownership of the underlying asset to the lessee by the end of the contract and does not contain termination options should be reported as a financed purchase by the lessee or a sale by the lessor.
Discount Rate – For the lessee, the discount rate for the lease is the rate implicit in the lease unless that rate cannot be readily determined. In that case, the lessee is required to use its incremental borrowing rate.
Exchange or Exchange –Like – A transaction in which each party receives and sacrifices something of approximately equal value.
Fiscal Funding Clause – A provision by which the lease is cancelable if the legislature or other funding authority does not appropriate the funds necessary for the government unit to fulfill its obligations under the lease agreement.
Implicit Rate – The rate of interest that at a given date, causes the aggregate present value of (a) the lease payments and (b) the amount that a lessor expects to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset and (2) any deferred initial indirect cost of the lessor. However, if the rate determined is less than zero, an implicit rate of zero should be used.
Incentive – This may be a discount or an offer to pay moving costs or make a cash payment to the lessee as a means to induce a lessee to sign a lease.
Incremental Borrowing Rate – The rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term in an amount equal to the lease payments in a similar economic environment. For entities within the state reporting entity (including USG institutions), this is the State’s incremental borrowing rate, provided by the State Accounting Office.
Lease – A contract that conveys 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.
Lease Term – The period in which a lessee has a non-cancelable right to use the underlying asset, plush periods covered by lessee or lessor’s option to extend the lease (if reasonably certain of being exercised) and periods covered by the lessee or lessor’s option to terminate lease (if reasonably certain of being exercised). Note that periods for which both the lessee and the lessor have an option to extend or terminate the lease without permission from the other party are excluded from the lease term.
Lessee – An entity that enters into a contract to obtain the right to use an underlying asset for a period of time in an exchange for consideration.
Lessor – An entity that enters into a contract to provide the right to use an underlying asset for a period of time in an exchange consideration.
Noncancelable Period – The period for which a lease contract is enforceable and the lease is cancellable only upon the occurrence of some remote contingency.
Nonfinancial Asset – An underlying asset that is not a financial asset as defined in GASB 72. Examples include: land, buildings, vehicles, and equipment.
Period of Time – The total period of time that an asset is used to fulfill a contract.
Regulated Lease – A lease in which there is another party that executes legal restrictions establishing the price that may be recovered through lease payments that significantly limits the lessors ability to set rates in excess of those limitations. Potential regulated leases may include airwaves, airports, technology, etc.
Reasonably certain – Implies a higher level of certainty. It is much greater to occur than likely to occur.
Residual Value Guarantee – A guarantee made to the lessor that the value of an underlying asset will be at least a specified amount at the end of the lease.
Right to Use – the right to obtain the present service capacity from use of the underlying asset and the right to determine the nature and manner of its use.
Short-term leases – Leases that, at the commencement of the lease, have a maximum possible term of 12 months or less, including any options to extend.
Sublease – A transaction in which the underlying asset is re-leased by the lessee (or immediate lessor) to a third party (the sub-lessee) and the original lease between the lessor and the lessee remains in effect.
Underlying Asset – An asset that is the subject for the lease for which a right to use the asset has been conveyed.
Variable Payments Based on Index – Payments that are linked to a benchmark and may fluctuate to reflect changes in market rental rates.
Variable Payments, In-Substance Fixed – Payments that are structured as variable lease payments but are in-substance fixed. This is when there are multiple sets of payments that a lessee could make, but it has to make at least one of these. An example of this the lessee has to pay $1 per mile for the vehicle lease or a minimum of $500.