The Governmental Accounting Standards Board is giving state and local governments extra time to implement its new leases standard because of the coronavirus pandemic, and they will probably need it because it has some complexities similar to those that businesses have been facing in applying the Financial Accounting Standards Board’s leases standard.
For fiscal years starting after June 15, 2021, state and local governments will have to adhere to GASB Statement No. 87. It was originally set to take effect for reporting periods starting after Dec. 15, 2019, but in May of this year, GASB issued Statement No. 95, pushing back the effective date of the leases standard and a number of other accounting standards and guidance for 18 months due to the challenges posed by the COVID-19 pandemic (see story). GASB’s sister organization, FASB, also decided in May to delay the effective date of the leases standard for private companies and nonprofit organizations for one year (see story).
“It’s very similar to what has been happening in the commercial world and in the nonprofit world under FASB,” said Tim Doyle, a partner in the Bonadio Group’s Government, Compliance, and Labor Division. “GASB 95 extended, due to COVID-19, a lot of the different pronouncements. This was actually extended 18 months, so the due dates for calendar year ends is Dec. 31, 2022, and for June year ends is June 30, 2022. It sounds like a long way off. However, there’s a lot of groundwork that needs to be done upfront in gathering the information, so we are telling our clients not to wait too long to do this.”
Both the FASB and GASB standards will put operating leases on the balance sheets of many entities for the first time ever. “The idea was to take these leases that in the governmental world had historically been reported as income statement type activities and get them onto the balance sheet,” said Doyle. “They did exclude certain things such as any leases that are 12 months or less. Those can still be treated the way that historically they have been treated.”
However, depending on the type of activity, the accounting will now change under the new standard. “If you think about a municipality or a school district, their fund basis of accounting is on modified accrual, and that has not changed at all,” Doyle explained. “This really just changes their entity-wide, or GASB 34, statements, which are full accrual. When we talk to a lot of our clients in terms of budgeting or the direct impact on their finances, for most governmental entities, municipalities and school districts, their funds and budgets are based upon fund accounting. This will not change that at all. However, if you are a proprietary fund, say if you have an arena, a municipal golf course, an airport or a community college, those are what they call business type activities. They’re enterprise funds and are required to record everything under full accrual. They would be impacted by this because their revenues and expenditures are full accrual. Historically if they were the lessor, they just reported this revenue as it came in and didn’t capitalize any of it. If they were the lessee, they recorded the expenditures and didn’t capitalize any of it. Now they will see a change. So for your standard municipality, there’s no real change from an operations standpoint. The same with school districts. But your business type activities, those enterprise funds, will see a difference because they’re full accrual.”
Many state and local governments will need to take inventory of their leases, similar to the way businesses have needed to collect all their leases to apply the new FASB standard. “First and foremost, you’ve got to gather all that information up and think about what leases you have,” said Doyle. “One of the difficulties that we’ve discovered with some of our clients is that some of those leases are outside of their business offices, so they may have different types of departments that are handling those leases themselves. They first need to get their arms around what leases they have, and what falls under the definition of this lease standard, and go through those agreements to see if they pertain or they don’t pertain.”
All those leases will have to be analyzed now to see if anything changes with the new standard. “Then they also need to have all of the inputs to value these leases,” said Doyle. “They need to know if there is a rate that is demonstrated on the document, the term of the document in terms of how long this lease would stand for, and obviously what the payments are. In the absence of an interest rate, you may have to base that upon recent lending activities and what rates you were receiving. They need to gather all those things. What we’ve tried to let all of our clients know is you need to figure out where all of these are because you may not have all of that information in your business office. You may need to reach out to each of your departments to determine if they have anything that would fall under this lease standard.”
Whether the government entity is a lessee or lessor and the type of lease, there may be an impact on the balance sheet or income statement. “Depending upon how much activity you determine that you have, it could be a very significant impact,” said Doyle. “You really need to think about your leasing space as well. We deal with a lot of schools and community colleges that are leasing out partial space to different entities, so they need to value that as to whether that needs to be recorded as a lease too. Each entity will be different, and depending upon the volume of activity, it could impact the balance sheet and income statement significantly.”
Finding all those old leases, particularly during the pandemic, could be a big challenge, but accounting firms can help them locate and sort through those documents. “The one thing we’ve talked about with our clients is because this is new, obviously it creates a lot of financial disclosures that are required, and you really need to gather up all these leases,” said Doyle. “A lot of places have had difficulties with that, just not having the manpower, and on top of that with everything that’s going on with COVID, the resources are stretched thin. We’ve actually put together a team here at Bonadio that can work with our clients and have started working with them toward identifying which leases are required to be implemented, how to value them, and even to the extent if they need us to go and gather these and compile them.”
The COVID-19 pandemic is already straining state and local governments around the country, with less tax revenue coming in for many of them as they continue to hope for more aid from the federal government. The new leases standard is likely to add more pressure on their budgets.
“I don’t think that there will be a direct effect on tax revenue, but potentially on their budgets,” said Doyle. “If you have any type of proprietary type funds such as a municipal golf course, an arena, an airport, those typically involve some level of transfers from the government to those funds to help offset expenses. Those funds, because they are full accrual financial statements because they’re business type activities, they are going to have an impact from this lease standard. To the degree that impacts them on their income statement, they may need more or less intergovernmental transfers, so that could indirectly affect the budget of the local government as they may need to support more or less those business type activities. The governmental activities themselves of the municipality will not change significantly in a direct fashion from this lease standard because they’re not required to report any of those on their funds statements. But the indirect effect is that some of their component units for funds that are business type activities will have a change and may need additional funding to offset that.”
His first piece of advice for his clients at Bonadio is to start early. “You cannot underestimate how much time this will take to gather and value,” said Doyle. “And if we’re going to offer advice, number two, ask for help. There are a lot of consultants out there, including us, so reach out to your advisors and consultants and ask for help because this is going to be a very significant standard with a lot of disclosures and a lot of accounting requirements.”