GASB 87, a new lease accounting standard for governmental entities, requires leases to be reported on the face of the financial statements and eliminates distinction between operating and capital leases. To comply, organizations must reevaluate contractual obligations to determine if they fall under the scope of the new guidance. The new standard applies to reporting periods beginning after June 15, 2021.
The process has been broken down into 9 steps to help with the implementation.
Step 1: Outline an implementation timeline.
Outline tasks that will need to be completed, their order and who has primary responsibility. Now, work backwards from the compliance deadline to schedule key milestones for implementation. Allow time for team members to get up to speed on the nuances of the new requirements and to complete their assigned tasks.
Step 2: Develop a system to collect leases.
Tracking down, identifying and organizing the universe of obligations that may be subject to GASB 87 might be the most time-intensive step in implementation. Before GASB 87, the world was divided between capital and operating leases. Start by creating two folders using those same categories and place all leases from your last audit in the appropriate folder. Add to the appropriate folder any new contracts you’ve executed since then that clearly fall into one of those categories. Remaining contracts — ones that didn’t fit nicely into the prior categories — should go into a third folder marked “other.” You’re now ready to do the tough work under GASB 87: reviewing obligations to flag embedded leases, non-lease components, etc.
Step 3: Categorize contracts and leases under the new guidance.
This is where the process can get tricky. Reclassify the contracts you’ve placed in your three folders into three new categories: debt, leases and expenses. If you have capital leases that transfer ownership at the end of the term but do not contain termination options, they likely belong in debt. Capital leases that do not transfer ownership or contain termination rights will go into leases. Next, place any short-term operating leases (those with terms of 12 months or less) into expenses. The rest of your operating leases will go into the lease category. Finally, take your “other” folder and organize the contracts between lessee or lessor. Place short-term contracts into the expenses category. If your contracts transfer ownership at the end of the lease period but do not contain termination options, place them into the debt category. Everything else goes into the lease category. Assess remaining contracts for embedded leases and then categorize appropriately.
Step 4: Identify and extract key data.
For every contract in your lease folder, identify the following information: 1) lease term, including renewal options, termination options, and fiscal funding or cancellation clauses; 2) payments; and 3) initial direct costs, incentives and prepayments. To expedite review, ask team members who are familiar with the contract details to help extract key information. If you have a significant number of contracts to review, or if your staff is already stretched thin, consider leveraging a lease management technology. A solution that helps with data abstraction, analysis and input can save your team weeks, even months, of work implementing GASB 87.
Step 5: Create initial schedules.
Populating schedules isn’t necessarily a complex task, but it’s critical you have a good process for accounting for all contracts and ensuring data is accurate. Your schedules and financial reporting will only be as good as your underlying data. Keep a few things in mind here. First, make sure to discount the lease payments using the appropriate interest rate to determine the beginning balance for your lease liability or receivable. Unless there’s a stated interest rate or you have information to calculate an implicit rate (which is rare), you’ll need to determine the appropriate incremental borrowing rate for each obligation. Second, use initial direct costs, incentives and prepayments to adjust the lease asset or deferred inflow of resources. Finally, consider materiality when processing your leases.
Step 6: Implement a review process.
Implementing GASB 87 is not easy. Anticipate that your team will make a few mistakes along the way, particularly the first time around. A consistent internal review process will help ensure you catch errors as you go. If your team already has plenty on its plate, consider engaging an outside advisor to assist with your review process and advise on any close calls or unusual situations. Outside experts can be an invaluable resource, helping you identify issues you may have missed or failed to consider. In either case, identify reviewers well in advance and make sure to give them enough time to thoroughly review and update the contracts and schedules before the next step.
Step 7: Remember journal entries.
Journal entries might not be as complex as you think, but entries related to GASB 87 will likely draw additional scrutiny from your auditor. So be thorough. Keep an eye out for any leases that were previously categorized as capital leases; in some cases, a restatement entry may be necessary for those obligations.
Step 8: Prepare note disclosures.
It’s now time to review and prepare disclosures. Many of the disclosures required by GASB 87 will be familiar — they’re just more robust under the new standard. One reminder when it comes to your disclosures: Right-of-use assets should be listed separately from other capital assets.
Step 9: Plan for ongoing compliance.
GASB 87 is here to stay. Embrace a framework for compliance now and begin to incorporate the process into your existing workflows to set up your organization for success in the future. Regardless of your approach, perhaps the most important takeaway is to get started on your GASB 87 efforts now. June 2022 will be here before you know it, and compliance won’t be easy to do well at the last minute.
Information obtained from Michael Juby