A version of this article was previously published in the July 2019 issue of Northwest Public Power Association Bulletin.
Many municipal utilities face significant changes to lease accounting and reporting requirements with the upcoming implementation of Governmental Accounting Standards Board Statement Number 87, Leases (GASB 87). These changes include revisions to the definition of a lease and amendments to the measurement, recognition, and financial statement disclosure requirements for leases.
The standard is effective for reporting periods beginning after December 15, 2019. Entities with December year-ends will start reporting under the new standard in 2020, and entities with fiscal year-ends will start in 2021. That means now is a good time to begin planning your implementation approach.
Under previous guidance, utilities could account for leases as either capital leases or operating leases. However, this created ambiguity for preparers and financial statement users, often leading to inconsistency and incomparable balance-sheet reporting.
Under the new standard, all entities will follow a single model for lease accounting, which is based on a principle that leases are ﬁnancings of the right to use an underlying asset. This approach is intended to enhance the relevance and consistency of information about utilities’ leasing activities and comparability of financial reporting.
Here are three steps your utility can take to prepare for implementation and benefit from changes introduced through the new standard.
Begin the GASB 87 implementation process by locating and analyzing all effective contracts and amendments in place at the utility, such as:
- Power supply contracts
- Pole attachments agreements
- Office equipment contracts
- Building lease documents
- Space lease documents
During this process, keep in mind that contracts may still be subject to GASB 87 even if they don’t include the word lease.
Definition of a Lease
The new lease reporting model treats all leases as financing transactions, which means a lessee is required to recognize a lease liability and an intangible right-to-use lease asset, and a lessor is required to recognize a lease receivable and a deferred inﬂow of resources. One exception exists for short-term leases, which are defined as leases that have a maximum possible term of 12 months or fewer. For these leases, lessees and lessors should recognize lease payments as expense or revenue, respectively.
GASB 87 defines a lease as a contract that conveys utility control of the right to use another entity’s nonfinancial underlying asset—such as a power plant, vehicle, building, or equipment—for a specified period of time. To qualify as a lease, this agreement must be made through a contracted exchange or exchange-like transaction.
Under the new definition of a lease, a contract conveys control of the right to use the underlying asset if both of the following criteria are met:
- Right to obtain the present service capacity from use of the underlying asset
- Right to determine the nature and manner of use of the underlying asset
Some agreements that may be excluded from lease reporting under this definition are supply contracts, such as power-purchase agreements, when they result in the purchase of a commodity that will be used in a utility’s normal operations.
A contract that conveys control of the right to use the underlying asset would be, for example, a contract between a utility and another party that allows the utility to gain full control of a portion of a power plant for a period of time. This contract would grant the utility access to additional power during specific months of the year.
An example of a contract that doesn’t convey control of the right to use the underlying asset is a power-purchase agreement in which the utility only purchases a commodity, such as natural gas or electricity, that will be used in its normal operations. In this example, the contract wouldn’t be a lease because the utility is solely receiving a commodity rather than obtaining control of the right to use the underlying asset.
After locating all contracts, your utility should review each contract, document which contracts convey control of the right to use the underlying asset, and calculate the right-to-use lease asset and lease liability that will be presented on your utility’s financial statements.
It’s important to thoroughly evaluate your utility’s chart of accounts to identify new accounts that must be added, such as:
- Intangible right-to-use assets
- Lease liabilities
- Lease receivables
- Deferred inflow of resources
Additional accounts may also need to be added to the statement of revenues, expenses, and changes in net position. However, the approach differs for lessees and lessors.
For a lessee, the right-of-use lease asset should be amortized in a systematic and rational manner over the shorter of the lease term or the useful life of the underlying asset. The amortization of the asset should be reported as amortization expense. Additionally, for a lessee, the lease liability should be reduced as payments are made, and the interest expense on the lease liability should be reported as an expense.
For a lessor, the lease receivable should be reduced as payments are received, and the interest revenue on the lease receivable should be reported as interest income. Additionally, the deferred inflow of resources should be recognized as revenue in a systematic and rational manner over the term of the lease.
Plan Your Approach
The new standard requires lessees and lessors to review all existing contracts to identify leasing arrangements, record contracts as assets or liabilities, and determine necessary changes to financial-statement presentation and disclosures for future years.
For many utilities, this process can be a substantial undertaking, requiring time, resources, and possibly additional personnel. That means it’s important for your utility to identify a team that can adequately locate and analyze your company’s documentation in a timely, efficient manner.
Many utilities assume financial-reporting preparation is the accounting department’s responsibility. However, changes introduced by GASB 87 make it necessary to pursue a more comprehensive approach.
While accounting personnel should be a central part of your review team, the team should also include key personnel from every department—such as legal, finance, and operations—who can discuss existing contracts, identify relevant documentation across different departments, and review large-scale implementation progress.
This team structure forms a system of checks and balances that helps prevent omission, while allowing the review team to locate and catalogue all relevant documentation subject to GASB 87 requirements.
Structure and Timeline
During initial meetings, your review team should discuss key elements of implementation—analyzing changes introduced by GASB 87, pinpointing potential implementation challenges, establishing a timeline, and determining an implementation approach.
It’s important to discuss key revisions introduced by GASB 87 and identify terms team members should focus on when reviewing the existing contracts. For example, any contract conveying the right to use a nonfinancial asset would be considered a lease.
Focusing on this term and others can help your team locate the 100% population of contracts. It’s also important to note that certain short-term contracts that are fewer than 12 months in duration are allowed to be excluded from the 100% population under the new standard.
Implementation challenges may include incorrectly labeled or missing documents or amendments to the existing agreements. To address this challenge, the team can establish a catalogue system that allows for completed information to be carried into future periods.
The implementation approach should include key milestones and the expected completion date to help the team gather information in the financial statements for two comparative years. Note that for comparative financial statement presentation, the standard requires restatement of the previous year’s results for consistency and comparability in presentation. That means all balances recorded in the year of implementation would need to be determined for the previous year as well.
For example, if your utility’s year-end is December 31, 2020, in the year of implementation, it would need to include an equal amount of information for the December 31, 2020, year-end and the December 31, 2019, year-end. This process must be completed by the required implementation year, but starting early makes the process more efficient.
Evaluate Internal Controls
Throughout the evaluation process, the review team should continually assess your utility’s existing internal controls and pinpoint areas for improvement—such as communication between operations and accounting, segregation of duties, monitoring, and IT infrastructure. Bolstering internal controls can help your utility implement and maintain lease accounting changes more quickly and efficiently, while improving communication throughout the organization.
A strong communication structure can help your utility efficiently accomplish key tasks, such as:
- Receiving and documenting important contract updates from legal and operations
- Supplying contract amendments and terminations to the accounting department to correctly update accounting for each contract
- Providing correct accounting and disclosure in the financial statements
Your utility’s communication structure should also help build the foundation for future financial-statement preparation. For example, the review team should have an efficient method for notifying the accounting team as soon as a new contract is amended to make sure accounting and financial statements are updated accordingly.
Segregation of Duties
Segregation of duties—the concept of having more than one person assigned to a given task—is a building block for strong internal controls that strengthen your utility’s network of checks and balances, helping prevent errors and reduce risk.
Here are a few tasks that should be assigned to a team and monitored throughout implementation and into future years:
- Preparing journal entries to be posted to the accounts
- Approving journal entries to be recorded in the general ledger
- Recording and maintaining the amortization schedules
- Entering new contracts in the system and calculating related amortization schedules
A strong IT system can help your utility achieve project goals while reducing allocated time and resources. Although upgrading existing IT system may not be practical for some utilities, finding a technology solution or using an existing system more efficiently, can help the review team:
- Implement GASB 87 requirements
- Compile and analyze time-consuming information
- Produce a timely annual financial report with more precise data
An effective technology platform can also help your company efficiently locate, organize, and summarize required data that would otherwise take a large team many hours to compile and finalize. Whichever solution your utility decides to implement, it’s important to assign proper segregation of duties, as described above, to review and approve schedules and other information generated from the system.
We’re Here to Help
For additional information about changes introduced through GASB 87 or how your utility can begin planning its implementation approach, contact your Moss Adams professional.