The Governmental Accounting Standards Board released updated implementation guidance for its leases standard, which is going into effect soon, along with other accounting standards for state and local governments.
The updated guidance, posted by GASB last week, provides information in the form of questions and answers on various topics, including accounting and financial reporting for derivative instruments, fiduciary activities, employee benefit plans, nonexchange transactions, capitalization policies, revenue from fines, capital project funds and other matters. Much of it is devoted to the leasing standard, GASB Statement 87.
Last year, GASB voted to defer the effective date of the leases standard, along with other standards, for state and local governments, to give them more time to adjust during the COVID-19 pandemic (see story), delaying it 18 months from Dec. 15, 2019. But now the effective date will be arriving shortly, for fiscal years beginning after June 15, 2021, and all reporting periods thereafter, according to GASB Statement 95. That’s also true for the implementation guide, which provides details on the definition of a lease, lease term reassessment, short-term leases, contracts that transfer ownership, lease recognition and measurement, lease incentives, lease modifications and terminations, and other matters.
Courtesy of GASB
That doesn’t mean the deadline is just days away, though. “GASB 87 is going to go into effect after a delay for entities with fiscal year ends beginning after June 15, 2021, so for entities that have year-ends that start July 1 — an example of that would be school districts, which is a special purpose government entity, and there are 13,000 of those in the country — they will have to address this standard for this next fiscal year,” said Joe Fitzgerald, senior vice president of lease market strategy at Visual Lease, a lease accounting software company.
While there’s still some time to get ready, state and local government accountants shouldn’t wait much longer to apply the new standard. “If they fail to have this in order before the deadline, they will likely face challenges in their journey toward achieving lease accounting compliance and maintaining it thereafter,” said Fitzgerald. “A little preparation ahead of time can help organizations align their strategy and timeline to start. However, now that we are closer to the deadline, there are other things they should also consider doing in parallel: analyzing data collected and reviewing report outputs are one of the final — but critical — steps to ensuring compliance. Key reports to pay attention to include the disclosure report, journal entry report and roll-forward reports, which are essential figures that will enable companies to successfully comply with the GASB 87 standard.”
Like the Financial Accounting Standards Board’s leasing standard, the GASB version will also put operating leases on the balance sheet for the first time for many entities.
“The ASC 842 standard, which is the standard that FASB issued and went into effect for publicly traded companies and will go into effect for private companies beginning in 2022, is very similar,” said Fitzgerald. “Governmental entities have had a lot of their leases off balance sheet as lessees, and effective with the new standard, they’re going to be bringing those new leases onto their balance sheet. They’re effectively going to transition from the current lease accounting, which is GASB 13, to GASB 87, and they will book an asset and a liability, which are more or less equal, but there will be what they call a ‘right of use asset’ on the balance sheet, effective the first of their fiscal year — July 1 in this case — and they will book a corresponding liability. It will be reflective, pretty much, of the net present value of the future minimum lease payments over the term as defined in the standard.”
Balance sheet liabilities for state and local governments are bound to increase, and that’s going to get the notice of credit-rating agencies. “Those balance sheets are going to blow up in effect, and that could impact a variety of things, one of which is that a lot of governmental agencies have credit ratings, so this is going to create additional liability on their balance sheets,” said Fitzgerald. “They’re going to have to give some thought to that, what it’s going to mean and how they’re going to be evaluated by the rating agencies.”
Some rating agencies would have already considered the obligations even though they were off balance sheet. “Even though they had been off balance sheet previously, there’s a disclosure in the footnotes that one could go to to look at your future lease obligations and then interpret that as to the impact on your financial statements,” said Fitzgerald. “In theory, it shouldn’t affect it, unless it turns out that you’re way off.”
When public companies had to reveal major discrepancies between their footnote disclosures of their lease obligations under ASC 842, they had to explain why. So when something’s off balance sheet, there’s not as much scrutiny and attention to detail. “There were a number of publicly traded companies that we saw where they thought their lease obligation was X and it turned out when they went on balance sheet, it was a multiple of that. Then you had some explaining to do,” Fitzgerald said.
He also advises government accountants to watch out for the “day one transition.”
“The other thing about lease accounting is that now that it’s going to be on the balance sheet, changes to your leases, which happen pretty regularly — more so than folks realize — will have to be evaluated,” Fitzgerald said. “For instance, if you had a three-year lease and along the way you changed it to a five-year lease, you in effect have to take a look at the modification and there may be a subsequent measurement of that lease. Or for a new lease, you have to take a harder look at that than you did in the past because it was off balance sheet and folks didn’t pay as much attention to it.”
Another lesson governments can learn from public companies that applied FASB’s ASC 842 standard during the pandemic relates to lease renegotiations. “We saw with publicly traded companies that have adopted their own standard, during COVID-19 there were a lot of renegotiations around leases,” said Fitzgerald. “Everybody was looking for relief. One thing they did was they went to their landlords for some relief, so there were a lot of real estate leases that were modified. Some of those modifications could have resulted in impairments or terminations of leases, and they have to be evaluated for accounting, whereas in the past, they may have been [treated] much more casually because there would have been no balance sheet impact.”
For publicly traded companies that have adopted the ASC 842 leases standard and put the right of use asset on their balance sheet, there were some valuation issues around the asset that’s now on the books. For government entities, after they adopt the GASB 87 standard, if they have any modifications to their leases, it could result in a new lease.
Technology will be an important consideration. “There’s got to be a lot of accuracy in terms of the data that’s collected and captured, and the timeliness that that data is updated into some kind of a technology platform so the accountants and the finance folks can evaluate it for the lease accounting,” said Fitzgerald. “In the past it was more just kind of flowing through their income statement, through their accounts payable.”
The lease accounting changes may prompt some government entities to look into buying instead of leasing assets, since the assets will be on the balance sheet anyway with GASB 87, as happened with some public companies that adopted ASC 842.
“Maybe they start to pivot more to starting to buy rather than leasing,” said Fitzgerald. “I saw some situations where entities had a lot of large equipment portfolios that they started to evaluate whether, in fact, leasing was the right answer for them. On the front end, you go in with an idea of leasing, and then what happens is you don’t return the equipment on time, for instance. So whatever negotiation you did on the front end to get the best rate and the best term, once you start going into what’s called the evergreen period, you kind of blew all the hard work you did on the front end to get the best deal on the lease, so I did see companies evaluate whether they should go to purchasing things.”
One example could be leasing fleets of vehicles. “We started to see companies looking at maybe they should start purchasing their fleet vehicles because in fact, they’ve kept them well beyond term. The other area I saw was in IT equipment, particularly laptops,” said Fitzgerald. “A large public company has a large portfolio of laptops, and they recognize that maybe they should just be buying them because they don’t necessarily keep them for three years or two years, or whatever the deal is. But the other reason is the leasing requires a lot more tracking of the assets, and a lot of companies recognized how hard it was to track them and where to get them back, so they were purchasing, not necessarily for the best lease rate, but just from more of a kind of a resource perspective. So I would expect to see some of that as the government entities start to bring this on the balance sheet. But it needs to be on the balance sheet first to come to some of those realizations.”
Government entities should be facing these decisions and preparing to implement the changes. “We see a lot of government entities with a June 30 year-end,” said Fitzgerald. “In theory, all those entities should have been getting ready for this standard now or even before today. We don’t see as many government entities in the market now, but we’re starting to see them more and more. I think they’re going to start to deal with this as they get closer to the end of the year, which will create some complications because they have to then, in effect, recast the lease activity that happens over the course of their next fiscal year for those modifications and changes to their leases.”
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