For both governmental and nongovernmental entities, this is the year that the new lease standards ASC 842 and GASB 87 provisions are set to go into effect. Both sets of standards contain similar changes to the prior lease reporting model, and both will have a dramatic impact on financial accounting and reporting for entities with leasing activity.
While many of the major provisions of ASC 842 and GASB 87 are similar, it’s important to be aware of some key differences for public and nonpublic entities. Here is a summary of the ways in which the two sets of accounting standards diverge.
Several standards promulgated by both the Financial Accounting Standards Board (FASB) and Governmental Accounting Standards Board (GASB) had their effective dates pushed back in early 2020 because of the COVID-19 pandemic, including the new lease standards. ASC 842 is now required to be adopted for fiscal periods beginning after December 15, 2021, for most entities, while GASB 87 is required to be adopted six months sooner with an effective date for fiscal periods beginning after June 15, 2021.
At least nominally, ASC 842 for non-public entities retains a two-category approach: operating leases and finance leases, which replaces the legacy term “capital leases.” GASB 87 however, creates a singular model for all leases with no distinction between operating leases and other lease types. It’s important to note that under GASB 87, any agreements that transfer ownership are not considered leases, they are financed purchases and not subject to the guidance found in the new lease standard.
GASB 87 requires full retrospective presentation, with all prior period financial statements restated for the requirements of the new standard, except where not practicable. The FASB gives a few alternatives in ASC 842: a modified retrospective comparative method and a modified retrospective effective date method. The former is essentially the same as the GASB standard, with full retrospective presentation; the latter is a prospective approach, which allows for prior periods to be presented according to the legacy (ASC 840) lease guidance.
As a practical expedient, ASC 842 allows for the use of a risk-free discount rate to substitute the incremental borrowing rate for agreements with no implicit rate. In most cases, this would be the U.S. Treasury rate for securities with similar terms as the agreement. GASB 87 offers no such alternative; instead, it defers to the guidance in GASB 62 for imputing an interest rate for agreements with no implicit rate.
Contracts that transfer ownership
These types of contracts fall under the category of finance leases under ASC 842, similar to the treatment of contracts that transfer ownership under the old standard (ASC 840), which were capital leases. According to GASB 87, these contracts are not leases and should instead be recorded as financed purchases outside of this new lease guidance. It’s important to note that the presence of a bargain purchase option does not constitute a transfer of ownership, regardless of the certainty that the option will be exercised.
Both sets of standards require lease components and nonlease components for reporting purposes. Where GASB and FASB diverge is ASC 842 allows reporters to combine and capitalize lease and non-lease elements of an agreement as a single lease component as a matter of accounting policy election, which must be made in the year of adoption. GASB 87 has no such practical expedient. Embedded leases must be separated and accounted for according to the new guidance.
Similar to other long-term liabilities, the two sets of standards diverge when it comes to disclosing maturities. FASB reporters will report the first five years of maturities related to leases then “thereafter” as a single amount. GASB 87 requires five years of payments to be disclosed, then in five-year increments thereafter. ASC 842 also doesn’t specifically require disclosure of residual value guarantees and termination penalties whereas GASB 87 specifically requires these elements to be disclosed.
Given the complexities in both sets of standards, it’s critical to understand the distinctions in each reporting entity.
How Wipfli can help
Wipfli’s audit and accounting team can help you navigate the changes in lease accounting standards. You want to be certain your organization is correctly applying the updated rules. Contact us to learn more or continue reading on.