Understanding GASB 87
GASB Statement No. 87, Leases, fundamentally changed how state and local governments account for leases. Effective for reporting periods beginning after June 15, 2021, the standard establishes a single model for lease accounting based on the principle that leases are financings of the right to use an underlying asset.
For government finance directors, this means most operating leases that were previously off-balance-sheet now require recognition of a right-of-use (ROU) asset and a corresponding lease liability on the statement of net position.
Key Concepts
Right-of-Use Asset
The lessee recognizes an intangible ROU asset at the commencement of the lease term. The initial measurement includes:
- Present value of lease payments expected to be made during the lease term
- Payments made to the lessor at or before the commencement of the lease term
- Initial direct costs that are ancillary to placing the asset in service
- Less any lease incentives received from the lessor at or before commencement
Lease Liability
The lease liability is measured at the present value of payments expected to be made during the lease term. This includes fixed payments, variable payments that depend on an index or rate, reasonably certain residual value guarantees, and the exercise price of a purchase option that is reasonably certain to be exercised.
Discount Rate
Selecting the appropriate discount rate is often the most challenging aspect of GASB 87 implementation. The standard requires the rate the lessor charges the lessee, which may be the rate implicit in the lease. When this rate cannot be readily determined — which is common — governments should use their own estimated incremental borrowing rate.
For many governments, the incremental borrowing rate can be estimated by reference to recent debt issuances, outstanding variable-rate obligations, or indicative rates from their financial advisor or underwriter.
Short-Term Lease Exception
GASB 87 provides a practical exception for short-term leases. A lease with a maximum possible term of 12 months or less (including any options to extend) at commencement can be excluded from the ROU asset/liability recognition requirements. Instead, payments are recognized as expense in the period they are due.
This exception is critical for government fleet leases, equipment rentals, and month-to-month arrangements.
Common Implementation Challenges
1. Identifying the Lease Population
Many governments discover they have far more leases than initially expected. Beyond obvious real estate leases, GASB 87 applies to equipment leases, vehicle leases, copier leases, postage meter leases, and even some service contracts that contain embedded leases.
2. Gathering Lease Data
Lease agreements may be scattered across departments, stored in filing cabinets, or managed by individual program managers. A systematic inventory process is essential — and should begin well before fiscal year-end.
3. Regulated Leases
Airport terminal leases, port berth leases, and other leases where rates are set by regulation or legal authority may qualify for the regulated lease exception under GASB 87, paragraph 20. These leases are recognized as revenue/expense in the periods they relate to, with no ROU asset or liability.
4. Lease Modifications
Changes to lease terms, payments, or scope after commencement require remeasurement of the ROU asset and liability. This is particularly common for government real estate leases, where renewals and amendments are frequent.
Journal Entry Example
Initial Recognition (Lessee)
For a 5-year office lease with annual payments of $120,000, discounted at 3.5%:
| Account | Debit | Credit |
|---|---|---|
| Right-of-Use Asset — Lease | $548,682 | |
| Lease Liability | $548,682 |
Annual Amortization and Interest
| Account | Debit | Credit |
|---|---|---|
| Amortization Expense | $109,736 | |
| Accumulated Amortization — ROU Asset | $109,736 | |
| Interest Expense | $19,204 | |
| Lease Liability | $100,796 | |
| Cash | $120,000 |
GFOA Best Practices
The Government Finance Officers Association recommends that governments:
- Begin the lease inventory process early
- Establish a centralized lease management system
- Document the methodology for determining incremental borrowing rates
- Consider technology solutions for ongoing lease tracking
- Coordinate with auditors on materiality thresholds for smaller leases
What's Next
GASB 87 implementation is now complete for most governments, but the ongoing compliance burden remains. New leases, modifications, and renewals require continued attention. The introduction of GASB 96 (SBITAs) in FY2023 added another layer of complexity, as cloud computing arrangements must be evaluated under a parallel framework.
GovtIntel will continue to provide implementation guidance, calculators, and AI-powered tools to help government finance teams manage their lease accounting obligations efficiently.