All ROU assets related to finance leases will be recorded as fixed assets in Oracle Fixed Assets with subsequent depreciation being recorded to the GL monthly by Oracle. These costs are incurred only if the lease is executed and would not have been incurred if the lease had been drafted and negotiated, but ultimately had not been signed by both parties. Select the template and click "Create" to use it. II. Examples include: the economic benefits from the University using a solar farm include the power generated by the solar panels and renewable energy credits obtained from using the assets to generate power; leased lab space used to generate specific research, leased office space used, held or subleased, or physical receipt of material produced by machinery. Note that the total payments for 2021 are $9,167 because a prepayment of $833 was required on the lease inception date, July 1, 2020. Leases that do not meet the requirements to be a direct financing or sales-type lease are, by default, classified as operating leases. Lease prepayments and incentives: If lease payments are made, or lease incentives received, prior to the lease commencement, such as the lease inception date, they should be recorded as prepaid rent. *The Lease Classification Quick Guide (Appendix C) provides guidance on how to calculate the present value of the lease payments. The term "amortization" is commonly used only to refer to the periodic allocation of the cost of a financial asset or an intangible asset, such as goodwill or a patent, over its economic useful life . These definitions must be considered when assessing what contracts are to be recognized as leases. The tub is responsible for the reconciliation of object codes 2793 (Capital Lease Equipment Liability) and 2794 (Capital Lease Building Liability). The lessee accounts for the lease when the organization takes possession of the asset, which represents the date at which the organization has the noncancelable right to use the asset. While a lease is "amortized" as a financial asset of the lessor, it is "depreciated" as a fixed asset by the lessee. Both finance and operating leases are recorded to the Balance Sheet as a Right-of-use asset and Lease liability, however, the methodology differs depending on lease classification. A rent-free period, an up-front cash payment, payment for tenant improvement allowance, and payment of lessee costs, such as moving expenses, are common lease incentives. Below we present the entry to record the lease as of 1/1/2021. Control: Control of an asset means that the lessee has the right to obtain substantially all of the economic benefits for the use of the asset and the right to direct the use of asset. The GASB summary covers the main points of the new guidance for those who are new to learning the new standard. Generally accepted accounting principles require operating leases to be recorded on the balance sheet as a ROU asset and Lease liability. As a result of GASB requiring an exchange or exchange-like transaction in contrast to ASC 842 specifying exchange for consideration, instances may occur where a contract is a lease under ASC 842 but not under GASB 87. For lessor arrangements, those Tubs that are lessors must notify FAR of leases that meet the thresholds noted under Section III and work with FAR to determine the appropriate accounting treatment, including necessary journal entries. We have summarized some of the key differences between GASB 87 and ASC 842. Lessor accounting under GASB 87 essentially mirrors the guidance for lessee accounting. 95, Postponement of the Effective Dates of Certain Authoritative Guidance, which delayed the GASB 87 effective date by 18 months. Include in rental income the basic rent amounts required under the lease terms plus any other reasonably certain amounts to be collected from the lessee. Tenant improvement allowances: Where a school/unit provides a tenant improvement allowance to a lessee, the capital improvement must be evaluated to determine if the University owns the leasehold improvement. Executory cost: Costs of an ongoing lease agreement. 4. Leases that dont meet these thresholds must be treated as operating leases. FAR coordinates the process of obtaining this information from the tubs each fiscal year-end using a reporting materiality threshold of $100,000 per lease. B. . Include in the deferred payment calculation are the basic rent amounts plus any other payments required under the lease terms (e.g., a lease non-renewal penalty or other likely payment required by the lessee). The Board notes this amortization expense represents an outflow synonymous to amortization expense; thus, we will refer to the finance leased asset amortization expense as depreciation expense. Operating leases are recognized on the balance sheet as their own financial statement line items (separate from finance leases) and are remeasured annually, with expenses recognized as rent/lease expense by the tub. The proper lease classification is important because it determines the Universitys accounting and reporting requirements. If both of the additional criterions are met, then the lease is classified as a Direct Financing Lease. Example: Accounting for a lease under GASB 87 with Excel. 5.3.5.2 Operating lease upon remeasurement. What Is an Amortization Schedule? How to Calculate with Formula The finance lease classification is a similar designation as the capital lease classification under the current GASB standard, just with a fresh nomenclature. The lease asset should be amortized, reported as an outflow of resources, in a systematic and rational manner over the lesser of the lease term or useful life of the underlying asset. Tubs should continue to depreciate the leased asset over its useful life and amortize any deferred initial direct costs. The lessee is the party granted use rights of an asset as part of an agreement. For leases that include a land element (e.g. Lessor: The owner of an asset that is leased under an agreement to a lessee. Subsequent entries will also decrease the lease liability and record interest expense. III. This policy provides guidance on determining the classification of an identified lease arrangement (i.e., for lessees: finance or operating; for lessors: direct financing, sales-type or operating) and establishes uniform thresholds and procedures when recording a lease. The lessee is determined to have control of the use of an asset if it has the ability to determine how the asset is used and the right to substantially all of the economic benefits arising from the asset. If significant executory costs are determinable at the lease commencement date, tubs should include these amounts in the lease payment present value measurement as part of the lease classification assessment in section. It is used to compare the annual interest between loans with different compounding terms (daily, monthly, annually, or other). Therefore the lessee will only include lease payments to be made on or after the commencement date in the lease liability calculation. A. Commencement date: The date when the lessor makes the asset available for the lessees use. Step 1: Create an Excel spreadsheet with these five columns Create a new Excel spreadsheet and title five columns with the following headers: Period, Cash, Expense, Liability Reduction, and Liability Balance, as shown below: Step 2: Enter the number of periods and cash payments It will also discuss some basic differences between lessee and lessor accounting. The lease asset value begins with the amount calculated as the lease liability. Initial Direct Costs: The sum of lease payments must include commissions paid upon executing the lease, and therefore must be included in the Commitments and Contingencies annual FAR request. Leasehold improvements Leasehold improvements: Lessor asset Leasehold improvements: Lessee asset Lease incentive impact to opening lease liability and ROU asset 3. In this example, the possession date (and the resulting lease commencement date) is January 1, 2021. Among other changes, it requires all public and private entities reporting under US GAAP to record the vast majority of their leases to the balance sheet. For example, a lease may contain a bargain purchase option (BPO), a lease clause that allows the lessee to obtain title to the leased facilities and/or equipment for less than its fair market value, for example a nominal amount such as $1, OR, Lease term: The lease term covers a majority (i.e., 75%) of the estimated economic life of the leased asset. For any units with a standalone audit requirement, locally materiality levels will need to be considered. GASB 87 vs. prior GASB guidance: Key differences, 4. Please remember to refer back to our blog frequently for important updates and changes to governmental accounting, including more guidance and insights on GASB 87 and GASB 96. Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position 2. amounts that will not vary based on changes in facts or circumstances that occur after the commencement date. Lease payments will have a portion that reduces the lease liability and a portion that flows through the statement of activities as interest expense. Assume a company (lessee) signs a lease for a forklift with the following information: Fair value: $16,000. The total payments for 2021 are $9,167 because the prepayment made on the lease inception date is relieved at lease commencement. Whether it is probable that the lessor will collect the lease payments and the residual value guarantee(s). Given the complexity of accounting rules for finance leases and the fact that it requires central-only object codes, FAR will prepare and upload the initial journal, establishing the finance lease asset and liability. The GASBs approach is consistent with IFRS 16 in that the lessee will classify all leases as financing arrangements. OR. Who Must ComplyAll Harvard University schools, tubs, local units, Affiliate Institutions, Allied Institutions and University-wide Initiatives must comply. GASB 87 defines the scope of leased assets as non-financial assets, such as land, buildings, equipment, and vehicles. For lessor arrangements, FAR has the following responsibilities: Work with the responsible school/unit to determine the appropriate accounting treatment for leases over the identified thresholds below, including necessary journal entries. However, if your organizations leases are recorded within a governmental fund, the modified accrual basis of accounting is used and a conversion entry will be necessary at year-end to create consolidated government-wide financials. 5.3 Accounting for lease remeasurement - lessee - Viewpoint There are two types of lease classifications for a lessee: finance and operating. Calculating a Lease Amortization Schedule - LeaseCrunch To calculate straight-line lease expense, aggregate the total cost of all payments and divide by the total contract term. What is a lease incentive? Leases must be evaluated to determine if they are operating leases, direct financing leases or sales-type leases, which, in turn, determine the appropriate accounting processes. If the school/unit retains ownership of the improvement, the improvement has a useful life beyond the lease term, the improvement has a value of $100,000 or more AND the University pays the construction vendor directly, then the capital improvement must be processed through the CAPS system in accordance with the Property, Plant and Equipment policy. Contact: Associate Director of Financial Reporting or your Tub Analyst. All other initial direct costs are expensed as incurred. ASC 842 Lease Accounting Guide: Examples, Effective Dates & More Read both implementation guides issued by GASB for detailed answers to specific application questions: Implementation Guide No. Rent expense is recorded on a straight line or cash basis (see thresholds below for distinction) throughout the year without an impact to the asset or liability. C. If the lease contains language on leasehold improvements that will be owned by the lessor, please consult with FAR for accounting implications, as it could impact lease classification or trigger a lease modification. Right of Use (ROU) Asset: An asset that represents a lessees right to use an underlying asset for the lease term. This pronouncement now requires the adoption of GASB 87 for all fiscal years beginning subsequent to June 15, 2021. Incremental borrowing rate: Interest rate a lessee would have to pay if, instead of leasing, they finance the purchase of the same asset. Weve compiled GASB 87 articles and resources below to help you get up to speed and keep up with the latest developments. Additionally, the definition of what constitutes a lease differs between standards; this definition is a critical distinction as it determines the impact on financial statements. What is Lease Amortization? This differs from finance leases, which result in depreciation and interest expense once all monthly and quarterly recurring entries are processed. Operating lease: From the perspective of a lessee, any lease other than a finance lease. Example: Accounting for a lease under GASB 87 with Excel, 6. If the balances in these accounts are greater than the reconciliation threshold of $1M, the quarterly reconciliations must be kept on file in accordance with the quarterly financial close checklist. You'll see a tool tip in the top left corner of the sheet as well as when you select the cells containing the loan details . Note: This example will continue to utilize an adoption date in 2020, in support of early adoption advised by the GASB. It's a lease incentive: How do we treat it? If the lease contains a tenant improvement allowance, this will not impact the value of the leasehold improvement (follow the PPE Policy for costs to capitalize). D. Make required disclosures for year-end lease reportingThe University is required to disclose the total gross assets and liabilities for finance and operating leases as well as both finance and operating lease commitments for each of the next five years and thereafter in its annual financial report. University is required to record a right-of-use (ROU) asset and a lease liability for finance leases at the lease commencement date. The lease obligation's amortization schedule reduces the $540,000 lease obligation by $36,000 so that the obligation for the second year is $504,000. The accounting treatment of a finance lease remains similar to the accounting treatment of a capital lease. GASB 87 vs. prior GASB guidance: Key differences. Step 2 - Input the applicable dates and payments This data will be taken directly from the lease agreement. However, the requirement to restate all prior periods presented, if practicable, remains. If these requirements are not met, the asset is recorded as a prepaid asset and is amortized over the life of the lease. For lessee arrangements, Tubs must notify FAR of leases that meet the thresholds noted under Section I below as they arise throughout the year, no later than quarter end, and must disclose finance and operating lease commitments for which the University is a lessee as part of the year-end financial reporting process. New leases: For purposes of this policy, new leases are leases entered into after 6/30/2022, including addenda to or extensions of existing leases. The tenant improvement allowance will be used as the funding source of the project.Please reach out to FAR for assistance with related journal entries. In this detailed example, we will walk through the appropriate accounting for a lease as a lessee in accordance with GASB 87 using full accrual accounting. DefinitionsCash Basis: Recognizing lease expense as cash is paid. B. Initial direct costs: Initial direct costs are the incremental costs of entering into a lease that are only incurred as a direct result of the lease being executed. Record Sales-Type and Direct Financing Leases CorrectlyA Sales Type Lease exists when it meets the above cash threshold and one of the criterions in section I.B.2 (lessee accounting) is met. Record Inter-Tub Leases ProperlyWhen assets are leased between tubs, they may only be accounted for as operating leases, and no gain or sale may be recognized on the transaction. Supporting documentation for any additional assumptions used in determining whether the lease is finance or operating. All liabilities related to finance leases will be recorded as Finance Lease Equipment Liability (object code 2793) or Finance Lease Building Liability (object code 2794). Calculate your monthly lease liabilities and ROU assets in compliance with ASC 842. For lessee arrangements, FAR has the following responsibilities: With information supplied by the tubs at lease commencement, FAR records the initial setup of finance lease assets and liabilities, for providing the amortization schedule for the lease liability, and for recording depreciation of the finance lease asset. Account fo rLeaseholder improvements - Lessee. Understand Rules for Lessee Accounting. These payments should follow local payment policies and guidelines for processing and approving payments. The determination of whether or not a contract is a lease or contains a lease is made at the lease inception date. Amortization is the process of paying off a debt over time through regularly scheduled payments. Generally accepted accounting principles do not require lessor operating leases to be recorded on the balance sheet. Escalating Rent Payments: Lease payments that are not of equal amounts but that escalate during the life of the lease should be recognized on a straight-line basis, unless another systematic and rational basis is more representative of the time pattern in which the leased property is physically employed, based on the above threshold. Fair market value: Probable price at which a willing buyer will pay to a willing seller when (1) both are unrelated, (2) know the relevant facts, (3) neither is under any compulsion to buy or sell, and (4) all rights and benefit inherent in (or attributable to) the item must have been included in the transfer. There are a number of other key differences across standards. Account for executory costs correctlyExecutory costs include utilities, repairs, maintenance, insurance, common area expenses, and taxes paid for the leased asset during its contract agreement period. Lease payments are amortized for the likely term of the lease by using the straight-line method. Period of Time: May be described in terms of the amount of use of an asset (e.g., number of production units ) or the number of years or months specified in an agreement. The two additional criteria are: This evaluation includes performing the assessment of lease payments described in Section I.B.2.d. The economic benefits from using an asset include the assets primary output and by-products. 2021-1 Implementation Guidance Update2021. Schools and Tubs are responsible for making all payments and journal entries. The incremental borrowing rate is an estimate of the interest rate that would be charged for borrowing the lease payment amounts during the lease term. These costs exclude legal fees, costs of evaluating the prospective lessees financial conditions, costs of negotiating lease terms, and general overheads. How to Calculate a Finance Lease under ASC 842 - Cradle Accounting IV. A tub must determine whether a contract is or contains a lease at this date. Ready to get started? What is lease amortization? - Pecunica The payment made at lease inception (i.e. Useful life of the forklift: 5 years. See Appendix B for an example that illustrates the amortization of a lease liability. Reference additional instructions for more details on the terms and calculations. A lease exists when there is a contract, or part of a contract, which conveys the right to control the use of an identified asset (property, plant, or equipment PP&E) for a period of time in exchange for consideration (i.e., payment). Executory costs include utilities, repairs, maintenance, insurance, common area expenses, and taxes paid for the leased asset during its economic life. ASC 842, or Topic 842, is the new lease accounting standard issued by the FASB and governs how entities record the financial impact of their lease agreements. With the new standard having such a profound impact on governmental financial statements, it is important to carefully review what exactly is considered a lease when conducting an inventory of leases. A lease is a finance lease if it meets certain criteria; if not, it is an operating lease.