Leases and Installment Purchases

3 Accounting

3.4 Liabilities

3.4.1 Leases and Installment Purchases

3.4.1.10 Lease definition

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.

3.4.1.20 Exclusions

The following items are not considered leases. For lessees that means these would not be reported on the Schedule of Liabilities (Schedule 09) as lease liabilities.

• Short-term leases – One that, at the beginning of the lease, has a maximum possible term of 12 months or less, including any options to extend - e.g. rolling month-to-month leases
• Interfund leases – Leases between departments or funds within the same government
• Lease of intangible assets – This includes mineral rights, patents, software, copyrights, except for the sublease of an intangible right-to-use asset created by the original lease of a tangible underlying asset
• Leases of biological assets – such as timber, living plants, and living animals
• Leases of inventory
• Service concession arrangements
• Assets financed with outstanding conduit debt – unless both the asset and conduit debt are reported by the lessor
• Supply contracts – such as power purchase agreements that do not convey control of the right to use the underlying power generating facility
• Certain regulated leases – such as aviation leases between airports and air carriers

3.4.1.30 Summary of BARS codes

3.4.1.40 Lessor accounting

Lessors only need to report the cash payments received for lease payments on the Schedule 01. Since lessors are receiving payments, there is no liability to report on the Schedule 09. To receipt payments, use either BARS Code 34P.PP or 362.00. If leasing is the primary operation/function of the fund that the payment is being receipted into, then use BARS Code 34P.PP which is a Charge for Services code. The “P” stands for prescribed numbers that are related to the function of the leasing activity. Review the chart of accounts to identify the applicable function and determine the full BARS Code. An example of when to use the 34P.PP code would be a port whose primary operation is leasing buildings.

If leasing is not the primary operation/function of the fund that the payment is being receipted into, then use BARS Code 362.00. An example of when to use BARS Code 362.00 is when a city or county is receipting lease payments into the general fund.

Lessors will use the revenue codes above for both short-term and long-term leases.

3.4.1.50 Lessee accounting and reporting

At the start of the lease, lessees will not report any inflows or outflows on the Schedule 01. Lessees will record actual lease payments made to the lessor on the Schedule 01 using BARS Code 591.PP.70.

Short term lease payments should be coded to normal, functional BARS expenditure codes. For example, if a government has a short-term lease for a copier that is used by the water utility fund, the lease expense would be coded to BARS 534.00.40.

Lessees are also required to include a note disclosure about their lease activity in the Notes to the Financial Statements. See template note at Note X – Leases (Lessees).

3.4.1.51 Variable and other non-lease payments

Variable payments should be excluded from the lease liability calculation. Variable payments are those that depend on future performance of the lessee or usage of the underlying asset. For example, a car lease may also include a charge per mile. The payment amount would vary depending on how many miles were driven, so the per mile charge would be excluded from the lease liability. Another type of variable payment would be charging a percentage of the lessee’s revenues.

However, if the variable payment is fixed in substance, it should be included in the calculations. For example, if a lessee is required to remit the greater of 10% of their sales or $5,000 each month, then the $5,000 payment is fixed in substance because the lessee will always be required to pay at least $5,000.

Some contracts include additional fees or taxes. Only the portion of the payment that is related to the right to use the asset should be included in the lease liability calculation. For example, if a copier lease also includes maintenance and sales tax, those are non-lease payments and should be excluded from the lease liability.

BARS Code 591 should only be used for the lease payments that are related to the right to use the asset. The variable and non-lease payments should be coded to regular, functional BARS expense codes.

3.4.1.52 Lease rate increases

Some contracts include clauses to increase the rates over time. There are two types of rate increases, known rate increases and variable rate increases. An example of a variable rate increase is an increase based on the Consumer Price Index (CPI) where the amount of the increase will vary depending on the CPI. An example of a known rate increase is a flat 3% annual increase where the increase amount is known and can be calculated for each period.

If the contract includes a variable rate increase, that rate increase should be ignored for purposes of calculating the liability on the Schedule of Liabilities, since the increase amount is unknown at the time of calculation.

For example, there is a 5-year lease that charges $500 per month for the first year and in each subsequent year the rent will be increased based on the CPI. The lease liability would be $30,000, which is $500 multiplied by 60 months (5 years). Since we do not know what the CPI increase will be in the future, the CPI increase is not factored into our calculation.

When making the monthly payment, only the original $500 used to calculate the liability should be coded to BARS 591.XX.70. For example, if the lease payment increased to $550 in the second year, the payment would be split into two different BARS codes: $500 would be charged to BARS 591.XX.70 and the remaining $50 would be charged to a functional BARS expense code.

Conversely, if a lease payment increases based on a flat rate, that should be factored into the liability. For example, there is a 5-year lease that charges $500 per month for the first year and each subsequent year the rent will be increased by 3%. The lease liability is $31,855 as shown below:

This increase is factored into the total liability because it is known and can be accurately calculated at the beginning of the lease.

3.4.21.43 Prepaid Leases

Some contracts require payment for all years of the contract upfront. When the entire term of the contract is paid at the beginning, this is a prepaid lease. For example, a government enters a lease contract for 5 years at a price of $10,000 per year. The government pays $50,000 for all 5 years at the beginning of the contract, so this is a prepaid lease. Prepaid leases are not reported on the Schedule of Liabilities since the government does not owe the lessor any additional payments.

3.4.1.55 Lessee Schedule 09 reporting

Lessees will report a lease liability on the Schedule 09 measured at the total amount of future lease payments. See Schedule 09 reporting instructions.

In the year of implementation, any existing leases should report a beginning balance on the Schedule 09. The beginning balance reported should be the total amount of lease payments that were remaining as of the beginning of the year. In subsequent years, the beginning balance should match the prior year ending balance.

Any leases that are entered into during the year will be reported as an addition on the Schedule 09. The addition will be the total amount of future lease payments.

Reductions are the amount the lease liability is reduced during the year, which is typically the amount of lease payments made.

If the lease liability is remeasured for any of the items listed in Section 3.4.1.70, the change in the lease liability should be reported as either an addition or reduction on the Schedule 09.

3.4.1.60 Lease term

To calculate the total amount of future lease payments for the schedule 09, you need to know how many payments you are expecting to make which depends on the lease term. Here is what should be included in the lease term:

• The period during which a lessee has a non-cancelable right to use an underlying asset
  • plus periods covered by a lessee’s or lessor’s option (contractual right) to extend the lease (if reasonably certain the option will be exercised)
  • and periods covered by the lessee’s or lessor’s option (contractual right) to terminate the lease (if reasonably certain the option will not be exercised)
• Lease term excludes periods for which both the lessee and lessor each have the option to terminate or both parties must agree to extend

In situations where contracts automatically renew, not canceling is the same as choosing to extend the contract.  As above, future renewals are not part of the lease term if both parties have the right to not renew (i.e. cannot be forced into continuing the contract).

Determining whether a lease option is reasonably certain of being exercised or not requires professional judgement and should take into consideration the specific facts and circumstances at your government. Examples of items to consider in this analysis:

• Is there a history of extending the lease?
• Is the item being leased essential to your government’s operations or services provided to citizens?
• Can the asset be leased from other sources?
• Any other factors relevant to your specific circumstances.

3.4.1.70 Remeasuring the lease liability

The lease liability reported on the Schedule 09 must be remeasured (recalculated) if any of the following happen:

• Change in lease term
  The lease term might change if you were previously not going to exercise an extension option, but then determine you will extend the lease (or vice versa). In that case you should recalculate the lease liability to include the additional payments related to extending the lease term.
• Change in likelihood of purchase option
  If you previously determined you were not going to purchase the asset, but later determine that you will purchase the asset, then you should start treating the contract like an installment sale (use BARS codes 594.PP.70 for payments and the installment purchase codes on the schedule 09). Sometimes purchase options require additional amounts to be paid at the end of the contract in order to purchase the asset, those additional amounts should be added to your installment purchase liability on the schedule 09.
• Contingency resolved for variable payments.
  If your lease payments were variable and later on all of your remaining lease payments become known (no longer variable), then you should recalculate the lease liability using the fixed known amounts.

3.4.1.80 Installment purchases (formerly called capital leases)

Leases that transferred ownership of the asset to the lessee were previously called capital leases. These are now called installment purchases. If a lease has a purchase option or bargain purchase option, you will need to determine whether that option will be exercised or not. If you determine the purchase option will not be exercised, treat the contract like a lease. If you determine that the purchase option will be exercised, treat the contract like a financed purchase.

3.4.1.85 Installment purchase accounting

You will add a liability to the Schedule 09 (Schedule of Liabilities) for the total amount of future payments, including the cost of any purchase options. At the start of the contract you do not record any inflows or outflows on your Schedule 01. You will record payments made on your Schedule 01 using BARS Code 594.PP.70. Some installment purchase contracts will include an interest charge. In that case, interest expenditure should be coded to BARS 592.XX.80.

If your government previously determined they would not exercise the purchase option, but then later do exercise it, you should start treating the contract as an installment purchase at the time the decision is made. That means you should start coding your remaining lease payments to BARS 594.PP.70. However, you should not go back and change the BARS codes of any of your previous payments.