ASC 842, GASB 87 implementation are here
Are you prepared?
Jason Parker, CPA, LeaseQuery | November 2021 Footnote
Editor's note: Updated October 29, 2021
As the year comes to a close, a topic accountants have been anticipating is finally just around the corner:
lease accounting! Depending on an entity’s specific fiscal year, all private organizations, as well as state and local governments, must soon adopt its jurisdiction’s new lease accounting requirements.
The Financial Accounting Standards Board’s (FASB) new standard, ASC (Accounting Standards Codification) 842, has an adoption deadline for private companies set for fiscal years beginning after Dec. 15, 2021; thus, if your entity publishes financials on a calendar-year basis, you must adopt the new guidance starting in January 2022.
The Governmental Accounting Standards Board’s (GASB) new standard, GASB 87, requires an adoption for all fiscal years beginning after June 15, 2021. Yes — that date has already occurred. For any municipality that has a June 30 fiscal year-end, you would need to adopt GASB 87 beginning
this current fiscal year. Both jurisdictions previously offered implementation delays to ease the adoption burden, but the time to adopt has arrived.
FASB began the process of reauthoring a practical expedient to further meet the needs and desires of both the entity and the financial statement users, where GASB more so clarified complex, yet relatively common scenarios for both lessees and lessors in its May 2021 Implementation Guidance Update. This article covers the final changes and clarifications the standards boards have issued to minimize complexity and confusion upon the initial adoption.
ASC 842
FASB authored an update to one existing practical expedient, which may simplify a private entity’s approach to adoption.
Risk-free rate practical expedient
Previously, FASB permitted private entities to use a risk-free rate — in the U.S., the rate of a zero-coupon U.S. treasury instrument — for the entire portfolio, as opposed to identifying an incremental borrowing rate, to reduce overall adoption complexity.
Given the minute size of the typical risk-free rate, private entities expressed concern that arrangements that would otherwise be classified as operating leases may meet the criteria for a finance lease if the lower risk-free rate caused the present value of lease payments to equal substantially all of the fair value. Additionally, material leases, such as long-term real estate, may balloon the balance sheet using a rate much smaller than the identified incremental borrowing rate.
To address concerns, FASB proposed
1 that non-Public Business Entities (non-PBEs) may elect the risk-free rate by underlying
asset class, as opposed to the all-or-nothing approach originally offered. This allows entities to use the incremental borrowing rate for material asset classes and simplify the adoption approach by using the risk-free rate for more voluminous, less material assets, such as equipment or vehicles.
1 Note: FASB has not yet published this update as an Accounting Standards Update, but the board does plan to issue this update in Q4 2021, prior to the effective date of ASC 842 for non-PBEs. Additionally, FASB plans to require entities to use a lease’s implicit rate, as opposed to the risk-free rate, in any scenario where the lessee can readily determine the implicit rate.
GASB 87
GASB issued an implementation guidance update in May 2021 to provide more detailed context on how to apply complex requirements.
Accrued interest
In paragraph 24 of GASB 87, the original standard noted that both lessees and lessors should initially allocate payment to outstanding interest and secondly to the remaining principal balance. This raised the question whether lessees/lessors should accrete the liability or receivable, respectively or recognize any capitalized interest in an entirely separate account.
GASB confirmed in the May 2021 guide (Q/A 4.10) that both lessees/lessors should capitalize accrued interest as a separate account, rather than simply accreting the existing principal balance.
Municipalities should consider this requirement another bullet point of potential complexity in ensuring completeness and accuracy upon adoption, given the common occurrence of leases with other-than-monthly payments, which would accrue interest during periods of nonpayment.
Short-term criteria identification
In paragraph 16 of GASB 87, leases that have a maximum possible term of 12 months or less qualify for the short-term exemption. For leases that qualify, GASB does
not require the entity to capitalize an asset and liability for the right-to-use and also does
not require municipalities to disclose costs associated with these exemptions.
Some governmental leases may extend beyond a year but may only offer the
right to use the asset for a total period of 12 months or less (e.g., an AAU basketball organization executing a three-year lease on a gym that allows them the right to direct use and obtain benefit from the asset during May–July of each year). Although the contract term shows a three-year period, the lessee can only
use the asset for a maximum term of nine months.
GASB confirmed (Q/A 4.7) that the municipality should measure for the short-term exemption using the right-to-use period, as opposed to the contractual period, in scenarios where the lessee can only use the asset for certain noted periods throughout the contract term.
Reassessment for cancelable periods
Paragraph 15b of GASB 87 provides a few scenarios in which lessees/lessors should reassess the lease term, and Paragraph 25 notes that the reassessment should occur at each financial reporting date because a reassessed lease term would ultimately lead to a remeasured liability and asset.
Questions have arisen whether a cancelable agreement — cancelable by both parties without needing the other party’s consent — with a notice period should have a recognized lease term. Given that a notice period to cancel creates a minimum period of use, one can clearly interpret that the notice period itself qualifies as the noncancelable period.
The implementation guidance update (Q/A 4.6) provides a scenario with a 24-month notice window for cancellation. Many observers questioned whether an entity choosing
not to cancel an agreement should account for the lease analogous to an entity choosing not to execute an option previously determined reasonably likely.
The implementation guidance update confirms governments should treat the two scenarios similarly; thus, at the end of a reporting period, an entity would:
- Reassess the term of the agreement to yet another full notice period.
- Subsequently remeasure the liability and asset, assuming the change significantly affects the liability and asset balances.
Both lessees and lessors should note this additional step upon closing out fiscal periods when ensuring completeness and accuracy under GASB 87.
Now is the time to act
As entities begin adopting the new lease guidance, keep in mind the complexity that exists beyond the initial calculations. All of the previously mentioned considerations include ongoing efforts, especially given the commonality of lease amendments and partial terminations. With the many new processes, controls and accounts needed to ensure proper oversight of lease accounting, entities should wait no longer to begin the adoption process. Public entities that adopted ASC 842 back in 2019 preach the time and effort necessary to adopt exceeded expectations, so we suggest taking that message as a hint to get started immediately!
Jason Parker is an accounting solutions manager at LeaseQuery. He began his career in the audit practice at KPMG, serving both public and private clients in a wide array of industries. Jason is a licensed CPA in the state of Georgia.
