Question

Summarise the Implications of GASB statements 87 on lease accounting.
cite references , following APA requirements and discuss the strengths and weaknesses of the topic.

Answer 1

Overview

Effective for fiscal years beginning January 1, 2020, a new approach for accounting and reporting leases will be required for state and local governments under GASB Statement 87, Leases. This standard, which will be applied retroactively, establishes a single model for the accounting of leases based on the principle that leases are financings of the right to use the underlying asset. The previous standard was considered by many critics to allow leases to be structured in ways that avoided reporting the economic reality of the transaction. GASB deemed the new standard necessary to ensure that the reporting of lease agreements was consistent with the conceptual framework of assets and liabilities as described under GASB Concepts Statement 4, Elements of the Financial Statements, which was issued in 2007.

Effects of GASB Statement 87

The biggest change in the new leasing standard with respect to state and local governments is that retroactive application to existing leases is now required. In contrast to the prospective approach for tax abatements taken by GASB Statement 77, governments will have to consider all leasing arrangements as of the date of implementation for GASB 87 and not at the inception of the lease.

Another significant effect of the new standard is that lease accounting will be quite different in for-profit entities as compared to most not-for-profit entities, including state and local governments. For example, not-for-profit hospitals and universities will follow the FASB guidelines for lease accounting, while governmental hospitals and universities will follow the GASB guidelines. The new standard should, however, result in more accurate financial analysis, as applying the single accounting approach to all leasing arrangements should eliminate the “bright-line standard” transaction structuring for those lease agreements that exceed one year.

The new standard will also have an impact on the financial statements of the lessee (Exhibit 2), which previously did not recognize either long-term assets or liabilities related to the leases if they were considered operating leases. The statement of net assets will have new asset and liability accounts, although overall net position will not be affected, due to offsetting assets and liabilities. The statement of activities will now include an amortization expense. Finally, note disclosure will be similar to current debt note disclosures for lessees (i.e., governments), which should provide descriptions of the leasing arrangements as well as inflows of resources for the period.

GASB Statement 87 Effects on Financial Statements

Statement of Net Assets

New assets and liability accounts

Statement of Activities

Amortization expense

Notes to Financial Statements

Disclosure of lease terms

From a financial ratio perspective, the recognition of lease liabilities will negatively impact debt ratios. Debt limits under current constitutional or statutory provisions must be considered, as governments must remain in compliance. The potential for balance sheet misstatement increases if not all leases are properly recorded. Systems and business processes may also have to change as a result of the new lease standard, including the retraining of staff and investment in lease accounting software.