There are countless challenges facing institutions of higher education in 2021. For those who follow governmental accounting standards, they must also implement GASB Statement No. 87, Leases.
All entities who follow this accounting standard system must implement the new standard for reporting periods beginning after June 15, 2021. This means they will need to have a plan in place by July 1 of this year for implementation of the standard.
So what exactly does this standard change about the current way we account for leases? One of the major changes is in the very definition of what constitutes a lease. According to the standard, a lease is “any 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.”
There is certainly a lot to unpack in this definition. The simplest interpretation is that a lease will exist when two parties enter into an agreement in which money is exchanged for the right to use an asset. An example of this would be the leasing of a building or piece of equipment. There are, however, some key items in the definition that broaden our existing definition of a lease.
- “Control of the right to use” – This does not mean control of the asset itself, as the benefits and burdens of ownership are not required to be transferred to classify an agreement as a lease.
- “Exchange or exchange-like” – This terminology will play a significant role in the identification of leases and the exclusion of some nominal leases.
The standard does come with notable exceptions, some of which may have been considered leases under different circumstances. Exceptions include the leases of intangible or biological assets, inventory, or assets financed with conduit debt (unless the lessor reports the asset and conduit debt). Also excluded from the applicability of the standard are service concession arrangements and supply contracts.
We now know what a lease is and what the GASB specifically excluded from the standard. However, what about some of those grey area items that happen quite frequently in higher education?
- $1 leases – We are all familiar with these. The university or its direct support organization leases land, facility space or another building with a readily determinable market rent value for just $1 per year. According to the GASB, this does not qualify as a lease. There is no exchange or exchange-like transaction since the amount of money exchanged is not on par with the market rent value.
- Short-term leases – There are often instances in which an entity enters a 12-month lease agreement with multiple extension opportunities (e.g., a 12-month period with five extensions under the same agreement). If this were the case, the statement would apply to this lease as it is not considered a short-term lease. A short-term lease must not exceed a term of 12 months (including any options to renew). The renewal option, regardless of whether they are exercised, negates this definition.
- Software/equipment – For leases that contain multiple underlying assets, such as software and the license to use the software, the lease components should be separated if the accounting treatment for each asset would be different. In the case of software and licensing, the license would not be subject to the standard, and the components would need to be separated.
- Construction of leased assets – In some instances, lease payments begin prior to the lessee taking physical possession of an asset or attaining access to the use of the underlying asset. In these cases, the lease term would not begin until such access or physical possession takes place.
Note disclosures will also be a significant part of the changes required by the standard. Their format could easily be borrowed from existing disclosures for capital assets and debt instruments. The elements of the disclosures are as follows:
- Total amount of assets recorded under leases and the related accumulated amortization (lessee)
- The cost of assets on lease or held for leasing (by major class) and the amount of accumulated depreciation (lessor)
- The amount of expense (lessee) or revenue recognized (lessor) during the period
- Schedule of future lease principal and interest payments to be made or received in each of the five subsequent years and in five-year increments thereafter
Now that we understand the changes and have our final destination in view, we can lay out the roadmap for implementation. A great first step is to begin with the end in mind and determine when you will need to implement the standard. By working backwards, you can ensure you are in compliance well before your audit. Determine key dates to ensure all necessary leases will be identified and accounted for.
Once you have determined when things need to take place, begin identifying what contracts are already considered leases and what contracts could be considered leases. The definition of a lease has been significantly broadened; many agreements that have not previously been recorded will need to be reflected in your financial statements. Consider also instituting a “lease threshold.” In practice, this would be similar to (and hopefully consistent with) your existing capitalization threshold for nominal leases that would be expensed.
It is extremely important to document the conclusions made as to what current agreements are leases and how your institution will determine what constitutes a lease. Your auditors will likely need to perform some testing on both the accuracy and the process of your determination. This means you will need to update your internal control documentation and policies to reflect the statement’s changes and keep records of how any current leases were deemed a lease under the new standard.
Remember that other departments and direct support organizations at your institution are likely going through the same situation. In fact, many of these entities may have lease agreements between each other. It’s best to coordinate your efforts so no stone is left unturned in identifying and properly classifying lease agreements.
Finally, reach out to your auditor. Conversations with your auditors during the implementation process can save your team from headaches and surprises during the audit.
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.