Are you ready for lease accounting?
Accounting and reporting standards and guidance for leases are changing for both GAAP and cash basis local governments, effective for fiscal years ending December 31, 2020, and after.
Although you won't be preparing your financial statements and notes until early 2021, those first lease payments under the new standard will begin to flow in January 2020. Will you be ready?
Accounting and reporting principles are changing
When it comes to the activity of leasing, you won't be doing anything different. But the accounting and reporting will change. The distinction between capital and operating leases will be gone.
Further, all leases will be based on the principle that leases are financings of the right to use an underlying asset. For GAAP governments, this means that an activity that formerly affected only the operating statement may now result in long-term assets, liabilities or deferred inflows on the statement of position.
For cash basis governments, this means additional Schedule 9 and note disclosure reporting your long-term lease liability.
Where do I start?
You can start by reviewing SAO's Leases project webpage, found under the BARS & Annual Filing tab. Here you'll find a summary of the new standard, key considerations, accounting guidance and other resources.
Think about internal controls and the long-term accounting the new standard requires. Evaluate the need to update your current policies and procedures as they relate to the new requirements. For example, consider a capitalization threshold for leases. Establish processes for quickly identifying new leases and communicating changes to existing leases to the finance department.
The most challenging step is to identify your existing leases. Depending on your government's structure, leases might be managed by several different departments. Activities that meet the new definition are not always referred to as “leases” and might be embedded in contracts and interlocal agreements. Identifying a complete population of leases might take more than a review of financial records. Consider forming an implementation workgroup that includes those who routinely enter into lease agreements and who will be affected now and in the future by the new standard.
Once you have your leases inventory, determine which ones will, and will not, be subject to the new accounting and reporting requirements. Several exceptions and exclusions can apply, and some leases might have multiple components such as lease, non-lease, sublease, and multiple underlying assets. Develop a methodology for allocating the cost to the different components. Some of these determinations will require professional judgment.
What am I looking for when evaluating leases?
For leases subject to the new accounting and reporting requirements, identify the key provisions that determine the measurement of lease liabilities or assets – the lease term, the payments, and the interest rate (GAAP governments only). Amounts should be recognized and measured using the facts and circumstances as they exist at the time of implementation.
- Lease term: The lease term includes not only the initial period during which a lessee has a noncancellable right to use the underlying asset, but also any options to extend, when it is reasonably certain those options will be exercised.
- Lease payments: Identify when and how much will be paid/received over the course of the lease. Amounts to be reported in the statement of position are measured at the present value of payments expected to be made during the lease term.
- Interest rate (GAAP governments only): To determine the present value, you will need a discount rate. The future lease payments should be discounted using the interest rate the lessor charges the lessee. This can be a challenge when the rate is not explicitly included in the agreement, which is often the case. An implicit rate can be used if there is sufficient information provided in the lease agreement to calculate one (see GASB Statement 62, paragraphs 173-187 for guidance). Otherwise, use the lessee's estimated incremental borrowing rate – the rate that would be charged for borrowing the lease payments during the lease term.
Accounting and reporting for leases
Please visit SAO's Leases project webpage in the BARS & Annual Filing menu for more information. Use this information to consider the need for new GL account numbers and the new standard's effect on your budget.
GAAP governments: See GASB Statement 87, Leases for more details including note disclosure requirements.
Cash basis governments: We will update the Cash Basis BARS Manual with additional information, including new note disclosures. This update will occur in late 2020. Until then, please visit our Leases project page for more information.