What Is GASB 87 and How It Affects Lease Accounting?

GASB 87, officially known as Statement No. 87, Leases, is an accounting standard issued by the Governmental Accounting Standards Board (GASB). Its primary objective is to enhance the financial reporting of lease agreements for state and local governmental entities across the United States. The standard aims to improve the transparency and comparability of financial statements by providing a more comprehensive view of an entity’s lease obligations and assets.

Fundamental Shift in Lease Accounting

GASB 87 introduced a significant conceptual change in how governmental entities account for leases. Previously, leases were categorized as either operating leases or capital leases, each with distinct accounting treatments. Operating leases generally did not appear on the balance sheet, while capital leases did. This dual classification model has been replaced with a single, comprehensive model for nearly all leases.

The new standard operates on the principle that leases represent financings of the right to use an underlying asset. Consequently, for most lease agreements, a governmental entity acting as a lessee is now required to recognize an intangible “right-to-use” (RTU) lease asset and a corresponding lease liability on its financial statements. This means that lease obligations, which previously might have been off-balance-sheet, are now brought onto the balance sheet, providing a more complete picture of a government’s financial commitments.

Identifying Leases and Their Scope

Under GASB 87, a lease is defined as a contract that conveys control of the right to use another entity’s nonfinancial asset for a period of time in an exchange or exchange-like transaction. Nonfinancial assets include items such as buildings, land, vehicles, and equipment. The standard applies to nearly all contracts that meet this definition.

However, certain arrangements are specifically excluded from GASB 87’s scope. These exclusions include short-term leases, defined as those with a maximum possible term of 12 months or less at the commencement of the lease, including any options to extend. Other excluded items are leases of intangible assets, biological assets, inventory, service concession arrangements, supply contracts, and leases of assets that are investments.

Accounting for Lease Assets and Liabilities (Lessees)

Governmental entities, when acting as lessees, are required to recognize a lease liability and an intangible right-to-use (RTU) lease asset at the beginning of the lease term. The lease liability is initially measured as the present value of the payments expected to be made over the lease term. This calculation considers the lease payments, reduced by any lease incentives received.

The RTU asset is initially measured at the amount of the initial lease liability, plus any payments made to the lessor at or before the lease’s commencement and certain direct costs. Subsequently, the RTU asset is amortized over the shorter of the lease term or the useful life of the underlying asset. The lease liability is subsequently measured by applying the interest method, recognizing interest expense over the lease term. Both the amortization of the RTU asset and the interest expense on the lease liability are recognized in the Statement of Activities. The lease asset and lease liability are presented on the Statement of Net Position.

Accounting for Lease Revenue and Receivables (Lessors)

When governmental entities act as lessors, they account for leases by initially recognizing a lease receivable and a corresponding deferred inflow of resources. The lease receivable is measured at the present value of lease payments expected to be received during the lease term, with a reduction for any estimated uncollectible amounts.

The deferred inflow of resources represents the unearned lease revenue that will be recognized over the lease term. Subsequently, the lessor applies the interest method to the lease receivable, recognizing interest income over the lease term. Lease revenue is recognized from the deferred inflow of resources as the lease payments become due or are earned. Both the lease receivable and the deferred inflow of resources are presented on the Statement of Net Position, while lease revenue and interest income are reported in the Statement of Activities.