3 Accounting
3.4 Liabilities
3.4.1 Leases
3.4.1.10 Introduction
The Governmental Accounting Standards Board (GASB) Codification Section L20 – Leases establishes standards of accounting and financial reporting for leases by lessees and lessors that address lease accounting and reporting.
The guidance in BARS sections 3.4.1.80 – 3.4.1.84 is specific to lessors and the guidance in section 3.4.1.90 – 3.4.1.96 is specific to lessees. The rest of this section applies to both lessors and lessees.
3.4.1.20 Definition
A lease is 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.
3.4.1.30 Exclusions
The following items should not follow lease accounting and reporting guidance:
- 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
3.4.1.40 Lease term
The lease term includes:
- 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 to extend the lease (if reasonably certain the option will be exercised)
- and periods covered by the lessee’s or lessor’s option 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
- Lease term excludes the period, if any, after the date at which a purchase option is reasonably certain to be exercised (GASB Cod. Sec. L20)
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:
- What is the past history of extending the lease or not?
- Is the item being leased essential to your government’s operations or services provided to citizens?
- Do you have other options for where you can lease this asset from?
- Any other factors relevant to your specific circumstances.
3.4.1.45 Short-term lease
A short-term lease is one that has a maximum possible term of 12 months or less. The maximum possible term includes all options to extend regardless of whether those options will be exercised or not.
Example: A lease contract has an initial noncancelable term of 6 months with an option for the lessee to extend for another year. The lessee will most likely not exercise that option.
This is not a short-term lease because the maximum possible term is 18 months. The extension option is included even if it will not be exercised. The lease term for accounting purposes would only be 6 months.
Lessors should recognize revenue and lessees should recognize an expense when lease payments are due based on the payment provisions of the lease contract.
3.4.1.50 Discount rate
The lease payments should be discounted using the rate the lessor charges the lessee. This may be a rate stated in the contract (if it’s a reasonable rate) or the implicit rate can be estimated. Governments are also allowed to impute the interest rate using guidance in GASB Codification Section I30 – Interest Costs – Imputation, but it is not required. However, the rate cannot be readily determined, then the lessee’s incremental borrowing rate may be used.
The incremental borrowing rate is the interest rate that a borrower would have to pay to finance an asset of that same type, over a similar term, in the current economic environment, and of a similar amount. This is the borrowing rate at the margin for new debt, and not necessarily the rate of other previously negotiated debt which may have a dissimilar borrowing profile.
Governments should use professional judgment to determine their best estimate for the interest rate, maximizing the use of observable information to get a base rate (a starting point). For example, a prime rate would be a reasonable starting place for determining the incremental borrowing rate. Another example would be reviewing a local bank's website for their published interest rates.
If the government determines that they could finance an asset at that base rate (the prime rate, or another reasonable starting point), then that base rate should be used. However, if there are economic factors that would make that rate unobtainable, then the base rate should be adjusted accordingly. It is up to governments to determine the most appropriate discount rate.
3.4.1.60 Remeasurement
Lessees and lessors are required to remeasure (recalculate) the lease liability or lease receivable in certain circumstances:
|
|
Lessee |
Lessor |
|---|---|---|
|
Change in lease term |
X |
X |
|
Change in likelihood of residual value guarantee |
X |
|
|
Change in likelihood of purchase option |
X |
|
|
Change in estimated amounts for payments already included |
X |
|
|
Change in interest rate lessor charges |
X |
X |
|
Contingency resolved for variable payments |
X |
X |
If a lease liability or receivable is remeasured for any of the changes above, the index or rate used for variable payments and the discount rate should also be updated. However, the liability does not need to be remeasured solely for a change in the index or rate used for variable payments or a change in the incremental borrowing rate (if used as the discount rate).
3.4.21.61 Variable and other non-lease payments
Variable payments should be excluded from the lease calculations. 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 calculations. For example, if a lease contract also includes sales tax or maintenance fees those are non-lease payments and should be excluded from the lease calculations.
For lessees, BARS Code 591 and 592 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.
3.4.21.62 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 calculating the lease balances, 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 payment will be increased based on the CPI. The lease calculations would assume the payment to be $500 for all 5 years of the contract. Since we do not know what the CPI increase will be in the future, the CPI increase is not factored into the calculation.
For lessees, when making the monthly payment, only the original $500 used to calculate the liability should be coded to BARS 591.XX.70 and 592.XX.80. For example, if the lease payment increased to $550 in the second year, the payment would be split: $500 would be charged to BARS 591.XX.70 and BARS 592.XX.80 and the remaining $50 is considered a variable payment would be charged to a functional BARS expense code.
Lessees are required to disclose the total variable payments made on lease contracts and lessors are required to disclose the variable payments received, so governments should develop a process to track these variable payments.
Conversely, if a lease payment increases based on a flat rate, that should be factored into the lease calculations. For example, there is a 5-year lease that charges $6,000 for the first year and each subsequent year the annual payment will be increased by 3%. This increase is factored into the lease calculations because it is known and can be accurately calculated at the beginning of the lease. The lessee and lessor would assume the annual payments increase each year as shown in the table below:
|
Year |
Annual payments |
|
1 |
$ 6,000 |
|
2 |
$ 6,180 |
|
3 |
$ 6,365 |
|
4 |
$ 6,556 |
|
5 |
$ 6,753 |
The lessee and lessor would calculate the present value of the payments in the table above to determine the lease liability and lease receivable, respectively.
3.4.1.70 Financed purchases/installment purchases (previously called capital leases)
A contract that transfers ownership of the underlying asset to the lessee by the end of the contract and does not contain a termination option, should be reported as a financed purchase by the lessee and a sale of the asset by the lessor.
3.4.1.80 Lessor accounting (Modified/Full Accrual)
At the start of the lease term the lessor will recognize a lease receivable and deferred inflow of resources. The lessor will also continue to recognize the underlying asset as their own capital asset. Lessors also have required note disclosures. See template note at Note X – Leases (Lessors).
3.4.1.81 Lease receivable
The initial lease receivable is measured at the present value of lease payments expected to be received during the lease term, reduced by any provision for estimated uncollectible amounts. The receivable should include the following:
- Fixed payments
- Variable payments that depend on an index or a rate (such as the Consumer Price Index or a market interest rate), initially measured using the index or rate as of the commencement of the lease term
- Variable payments that are fixed in substance
- Residual value guarantee payments that are fixed in substance
- Any lease incentives payable to the lessee.
As the lessee makes payments, the lessor will recognize a reduction in the lease receivable and interest revenue. The lease receivable must be amortized using the interest method (GASB Implementation Guide No. 2019-3, Leases, paragraph 4.49).
If the entire lease contract is paid upfront (a prepaid lease), then there is no lease receivable (since the entire contract has already been paid). For example, the lease contract is for 5 years at a price of $10,000 per year. The lessee pays $50,000 for all 5 years at the beginning of the contract, so this is a prepaid lease. The lessor reports no lease liability. Instead, the lessor reports unearned revenue at the beginning of the contract and will recognize the revenue over the lease term.
3.4.1.82 Deferred inflow
The initial deferred inflow is measured at the amount of the lease receivable plus lease payments received from the lessee at the start of the lease term that relate to a future period (for example receiving the last month’s rent upfront).
The deferred inflow is amortized in a systematic and rationale manner over the lease term. GASB does not specify a required amortization method, so lessors may choose which method they use (for example the interest method or straight-line).
3.4.1.83 Lessor BARS codes
The lessor records lease revenue and interest revenue. The interest revenue from leases should be recorded to BARS Code 361.4P which is a non-operating revenue code. GASB Implementation Guide 2021-1, Question 4.13 clarified that all interest revenue earned from leases should be reported as non-operating revenue.
The lease revenue should be recorded to BARS Code 34P.PP (Charge for Services code) or 362. In a proprietary fund, use BARS Code 362 for non-operating lease revenue, and 34P.PP for operating lease revenue. In a governmental fund, use BARS Code 362 for leases that are not tied to a specific operation or function or for leases that are infrequent in nature. Lessors will also use these codes for short-term lease revenue.
Leases that are terminated will have a gain (loss) for the difference between the deferred inflows and lease receivable. This gain (loss) should be reported to BARS Code 395.90.00 Gain/Loss on Lessor Lease Termination. This code is for both modified and full accrual lessor transactions.
The “P” stands for prescribed numbers that are related to the function of the leasing activity. Review your chart of accounts to identify the applicable function and determine the full BARS Code.
3.4.1.84 Lessor example journal entries
A County leases equipment to a City in a 60 month lease. The payments are $1,000 per month (made at the beginning of the month) and the County uses an annual discount rate of 3%.
The County first calculates the present value of the lease to be $55,791 to record the initial lease journal entry:
|
Lease receivable |
55,791 |
|
|
Deferred inflow |
|
55,791 |
The County records the first month’s lease receipt. Since this payment is received at the very start of the lease, the present value is $1,000 and all of the payment goes towards principal and directly reduces the lease receivable.
|
Cash |
1,000 |
|
|
Lease receivable |
|
1,000 |
The County also records the first month’s deferred inflow amortization. This example uses straight line amortization in this example ($55,791 initial deferred inflow divided by 60 total payments equals monthly amortization of $930). This will be the exact same journal entry each month since straight line amortization is used.
|
Deferred inflow |
930 |
|
|
Lease revenue (BARS 34P.PP or 362) |
|
930 |
The County records the second month’s lease receipt. This time there is interest revenue, because one month of interest has accrued. The interest is calculated by multiplying the balance of the lease receivable from the prior month of $54,791 ($55,791 initial lease receivable minus the $1,000 payment in the first month) by the monthly interest rate of 0.25% (annual interest rate of 3% divided by 12 months). The remaining portion of the payment is the principal amount that reduces the lease receivable.
|
Cash |
1,000 |
|
|
Lease receivable |
|
863 |
|
Interest revenue (BARS 361.4P) |
|
137 |
The lease is terminated at the end of year 3. The receivable balance is $23,266 and the deferred inflow balance is $22,316. Both balances must be removed from lessor's financial statements. The difference between the two is reported as a gain (loss). In governmental fund financial statements, the gain (loss) should be classified as an other financing source (use).
|
Deferred inflow |
22,316 |
|
|
Gain/Loss on Lessor Lease Termination (BARS 395.90.00) |
950 |
|
|
Lease receivable |
|
23,266 |
3.4.1.90 Lessee accounting
For full accrual reporting (such as the government wide financial statements and proprietary fund statements) at the start of the lease term, the lessee will recognize a lease liability and lease asset.
The lessee will report lease liabilities on the Schedule of Liabilities (Schedule 09). In the year of implementation, any existing leases should report a beginning balance on the Schedule 09. The beginning balance reported should be the amount calculated for the implementation of GASBS No. 87. In subsequent years, the beginning balance should match the prior year ending balance.
Any new leases entered into during the year will be reported as an addition on the Schedule 09. The addition will be the liability calculated to add the lease to your financial statements.
Reductions are the amount the lease liability is reduced during the year, which is typically the principal portion of payments made.
If the lease is remeasured for any of the items in Section 3.4.1.60, the change in the lease liability should be reported as either an addition or reduction on the Schedule 09.
See Schedule 09 reporting instructions.
Lessees also have required note disclosures. See template note at Note X – Leases (Lessees).
3.4.1.91 Lease liability – full accrual
The lease liability is measured at the present value of payments expected to be made during the lease term. This includes:
- Fixed payments
- Variable payments that depend on an index or a rate (such as the Consumer Price Index or a market interest rate), initially measured using the index or rate as of the commencement of the lease term
- Variable payments that are fixed in substance
- Amounts that are reasonably certain of being required to be paid by the lessee under residual value guarantees
- The exercise price of a purchase option if it is reasonably certain that the lessee will exercise that option
- Payments for penalties for terminating the lease, if the lease term reflects the lessee exercising (1) an option to terminate the lease or (2) a fiscal funding or cancellation clause
- Any lease incentives receivable from the lessor
- Any other payments that are reasonably certain of being required based on an assessment of all relevant factors
As the lessee makes payments, they reduce the lease liability and recognize interest expense. The lease liability must be amortized using the interest method (GASB Statement No. 87, paragraph 24).
3.4.1.92 Lease asset – full accrual
The lease asset is measured at the initial lease liability plus lease payments made before the start of the lease term, plus any direct ancillary costs necessary to place the lease asset into service, minus any lease incentives received from the lessor before the start of the lease term.
If the entire lease contract is paid upfront (a prepaid lease), then lease asset is equal to the amount paid (no present value calculations) and there is no lease liability to report (since the entire contract has already been paid). For example, a lease contract is for 5 years at a price of $10,000 per year. The lessee pays $50,000 for all 5 years at the beginning of the contract, so this is a prepaid lease. The lessee would report a lease asset of $50,000 and no lease liability.
The lease asset should be amortized over the shorter of the lease term or the underlying asset’s useful life. GASB does not specify a required amortization method, so lessors may choose which method they use (for example the interest method or straight-line).
3.4.1.93 Lease reporting in governmental funds
Governmental funds do not report a lease asset or lease liability. Instead the lessee would record a Capital Outlay Expenditure (debit) and an Other Financing Source for leases (credit). As the lessee makes payments, they would record a Debt Service Principal Expenditure (debit), Debt Service Interest Expenditure (debit), and reduce cash (credit).
3.4.1.94 Lessee BARS codes
In a full accrual fund, the only revenue and expense accounts used are interest expense, amortization expense, and gain (loss) on lease termination, if applicable.
| 592.PP.80 | Recording interest expense payments |
| 501.PP.00 | Recording amortization expense on lease asset |
| 373.00.00 | Recording gain (loss) on lease termination |
In a modified accrual there is no lease asset or lease liability, so the accounts used are different.
| 594.PP.60 | Recording the capital outlay expenditure at the start of the lease |
| 391.70.00 | Recording the “other financing source” at the start of the lease |
| 591.PP.70 | Recording debt principal payments |
| 592.PP.80 | Recording interest expense payments |
The “P” stands for prescribed numbers that are related to the function of the leasing activity. Review your chart of accounts to identify the applicable function and determine the full BARS Code.
Expenses for short-term leases should be coded to the regular, functional BARS expense/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.
3.4.1.95 Lessee example journal entries – full accrual
A County leases equipment to a City in a 60 month lease. The payments are $1,000 per month (made at the beginning of the month) and the County uses an annual discount rate of 3%.
The City first calculates the present value of the lease to be $55,791 to record the initial lease journal entry:
|
Lease asset |
55,791 |
|
|
Lease liability |
|
55,791 |
The City records the first month’s lease payment. Since this payment is received at the very start of the lease, the present value is $1,000 and all of the payment goes towards principal and directly reduces the lease liability.
|
Lease liability |
1,000 |
|
|
Cash |
|
1,000 |
The City also records the first month’s lease asset amortization. This example uses straight line amortization in this example ($55,791 initial lease asset divided by 60 total payments equals monthly amortization of $930). This will be the exact same journal entry each month since straight line amortization is used.
|
Amortization expense (BARS 501.PP.00) |
930 |
|
|
Accumulated amortization – lease asset |
|
930 |
The City records the second month’s lease payment. This time there is interest expense, because one month of interest has accrued. The interest is calculated by multiplying the balance of the lease liability from the prior month of $54,791 ($55,791 initial lease receivable minus the $1,000 payment in the first month) by the monthly interest rate of 0.25% (annual interest rate of 3% divided by 12 months). The remaining portion of the payment is the principal amount that reduces the lease liability.
|
Lease liability |
863 |
|
|
Interest expense (BARS 592.PP.80) |
137 |
|
|
Cash |
|
1,000 |
The lease is terminated at the end of year 3. The liability balance is $23,266 and the lease asset balance is $55,791 with accumulated amortization of $33,475. These balances must be removed from the lessee's financial statements. The difference between the net lease asset and lease liability is reported as a gain (loss) on disposal of capital assets since lease assets are a type of capital asset.
|
Lease asset |
55,791 |
|
|
Gains (Losses) on Capital Assets (BARS 373.00.00) |
950 |
|
|
Lease liability |
|
23,266 |
|
Accumulated amortization on lease asset |
|
33,475 |
3.4.1.96 Lessee example journal entries – modified accrual
A County leases equipment to a City in a 60 month lease. The payments are $1,000 per month (made at the beginning of the month) and the County uses an annual discount rate of 3%.
The City first calculates the present value of the lease to be $55,791 to record the initial lease journal entry. Since the modified accrual funds do not record a lease asset or lease liability different accounts are used. However, the amounts calculated for the full accrual journal entries are the exact same that are used for the modified accrual journal entries.
|
Capital outlay – lease asset (BARS 594.PP.60) |
55,791 |
|
|
Other financing source – lease (BARS 391.70.00) |
|
55,791 |
The City records the first month’s lease payment. Since this payment is received at the very start of the lease, the present value is $1,000 and all of the payment goes towards principal. Since there is no lease liability to reduce, the payment is recorded as a debt service expenditure.
|
Debt service expenditure – principal (BARS 591.PP.70) |
1,000 |
|
|
Cash |
|
1,000 |
There is no lease asset in the modified accrual fund, therefore there is nothing to amortize.
The City records the second month’s lease payment. This time there is interest expense, because one month of interest has accrued. The same amounts calculated for the full accrual journal entries are used.
|
Debt service expenditure – principal (BARS 591.PP.70) |
863 |
|
|
Debt service expenditure – interest (BARS 592.PP.80) |
137 |
|
|
Cash |
|
1,000 |
The lease is terminated at the end of year 3. There is no impact to modified accrual statements because neither the lease asset nor the lease liability are reported in governmental fund financial statements.
3.4.1.100 Other topics
See GASB Codification Section L20 – Leases for guidance on additional lease topics such as:
- Lease incentives
- Contracts combinations
- Lease modifications and terminations
- Subleases
- Sale-leaseback transactions
- Intra-entity leases
- Leases between related parties.