Steven J. Cohen Principal, CPA, CGFM
is capital (where an asset and liability is recognized at lease inception) or operating (no balance sheet recognition) as this new pronouncement requires recognition of an asset and liability of almost all lease obligations.
When determining the governmental entities right to use the underlying asset, the contract must specify that the governmental entity has:
a. the right to obtain the present service capacity from the underlying
b. the right to determine the nature and manner of use of the underlying asset. Both attributes must be present for the governmental entity to be considered having “ownership rights” over the underlying asset.
“Contract for a period of time” represents the lease term. GASB 87 states that the lease term includes the period as stated in the contract during which a lessee has the right to use an underlying asset as well as any additional periods listed where it is reasonably certain that the lessee or lessor will exercise the option to extend the lease. Periods with a termination clause are also included in the lease term if, based on all relevant factors, it is reasonably certain the option to terminate will not be exercised by the lessee or lessor. Conversely, where it is reasonably certain that the option to terminate will be exercised, the
period covered by the termination clause is excluded from the lease term.
An exchange or exchange-like transaction occurs when the parties involved receive and give up items of an approximate value. Contracts that are non-exchange transactions would not be considered a lease under GASB 87. Examples of non-exchange transactions include donations and some grants that are dependent upon certain requirements or Federal/state entitlements.
GASB 87 also contains requirements regarding leases between related parties. The pronouncement states that “In the separate financial statements of the related parties, the classification and accounting should be the same as for similar leases between unrelated parties…” GASB specifically cautions against related parties entering lease agreements that seek to avoid lease accounting. If the agreements meet the spirit of the rule, the accounting should be modified to reflect the GASB lease requirements. For example, contracts that are designed to comply as a short-term lease but there is an understanding between the related parties that the lease can and will be extended for several years should not be excluded from lease accounting requirements.
To prepare for the implementation of GASB 87, we recommend all governmental entities:
- review all contracts to determine the existence of a lease under
- review cash disbursements for any recurring payments made to
the same vendor which may identify contracts that were previously
- consider the possible material effect GASB 87 may have on financial institution debt covenants including the current ratio and debt coverage ratio. Changes to any debt covenant ratios should be discussed with your financial institution.
If you have any questions about GASB 87, please contact Steven Cohen, CPA, CGFM at 617.471.1120 or [email protected] directly.