On January 25, 2016 the Governmental Accounting Standards Board (GASB) released an exposure draft entitled Leases. This standard promises to greatly change the face of lease accounting for organizations that must follow GASB. Many contracts currently treated as costs of operations may become applicable to be shown as long-term leases on the Statement of Net Position.
Overall requirements to record a long-term lease asset and liability
The proposed Statement establishes a single model for lease accounting based on the principle that leases are financings of the right to use an underlying asset. Under the proposed Statement, a lessee would be required to recognize a lease liability and an intangible right-to-use lease asset.
A lease would be defined as a contract that conveys the right to use a nonfinancial asset 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 would be accounted for under the proposed lease guidance unless specifically excluded. Leases include contracts that, although not explicitly identified as leases, meet the GASB definition of a lease, i.e., the right to use a nonfinancial asset.
This standard would apply to contracts where a lessee has a noncancelable right to use an underlying asset for a period of more than twelve months. Leases of under a term of twelve months or less would consider current operating costs.
Application of this standard will go beyond what we traditionally think of for leased assets, i.e., copier contracts, vehicle leases, and the like. Based on the right to use and underlying asset, any assets we use through contracts that provide a benefit to your utility are potential candidates.
- Power purchase agreements (where the underlying assets are not recorded as utility assets)
- Equipment contracts
- Building leases
Also, the standard requires the application to be made to contracts that may not be explicitly identified as leases.
Measurement and amortization period
The lease liability will be measured at the present value of payments expected to be made for the lease term. If the contract contains fixed and variable cost components, the lease asset/liability will be measured as a component of the fixed costs and variable costs of the contract are recognized as period operation costs. In general, the amortization period is the shorter of the lease term or the useful life of the underlying asset unless the lease contains a purchase option that will most likely be exercised, then the lease asset should be amortized over the useful life of the underlying asset.
The requirements of the proposed Statement would be effective for reporting periods beginning after December 15, 2018. Earlier application is permitted. Implementation of the standard requires restatement of prior periods presented in the financial statements.
Next steps to consider
Long term, recognize that this exposure draft will be implemented in some similar form as an established standard. Proactively you should develop a work plan to identify current contracts that will qualify for this treatment and proceed through an identification phase to qualify contracts and quantify the impact. Part of that plan should be to develop policies and procedures to identify future contracts that will meet the new standard in order to identify the proper accounting treatment from the contractual start date.
In evaluating contracts, consider the following:
Baker Tilly partners who currently sit on the AICPA Technical Issues Committee (TIC) and AICPA State and Local Government Expert Panel have provided input to GASB in the form of comment letters for the respective committees. Our firm will also be testifying on behalf of the AICPA TIC committee at the GASB public hearing on leases on July 29th.
For more information on the impact of this standard and how you can ready your organization for implementation, contact our team.