GASB 87 vs. ASC 842: Government vs. Private Sector Lease Accounting

The accounting treatment of leases represents one of the most significant divergences between government and private-sector accounting standards. For decades, both governments and private companies treated most leases as operating leases, reporting only rent expense on the income statement. In 2016, the Financial Accounting Standards Board (FASB) issued ASC 842, requiring private companies to capitalize virtually all leases on the balance sheet. In 2019, the Governmental Accounting Standards Board (GASB) issued GASB 87, introducing a similar but meaningfully different lease capitalization model for governments.

While both standards moved away from the old "off-balance-sheet" treatment of operating leases, GASB 87 and ASC 842 diverge in critical ways: GASB 87 retains a dual model (with some leases remaining off-balance-sheet), while ASC 842 moves to a single model. The discount rate, the treatment of variable payments, and the regulatory exceptions differ significantly. For organizations operating in both sectors (a healthcare system with government contracts, for example), these differences create compliance complexity.

This comparison provides practitioners with a clear-eyed assessment of the two standards.

Pre-Standard Accounting: Why Change Was Needed

Before ASC 842 (2019) and GASB 87 (2021), lease accounting was fragmented:

The Old Debate: Operating vs. Capital Leases

Under the previous standard (ASC 840 for private sector, GASB 13 for government), a lease was classified as either:

Operating Lease: Rent expense on the income statement; no balance sheet liability
Capital Lease: Asset and liability on the balance sheet; depreciation and interest expense on the income statement

The classification turned on mechanical tests: Did the lease transfer ownership? Was the term ≥75% of asset life? Was the present value of payments ≥90% of fair value?

The Abuse and Arbitrage

Sophisticated lessees exploited these tests to keep leases off the balance sheet, even when economically similar to ownership. A 10-year lease on a 15-year asset could be structured to avoid the 75% test and be reported as operating. The result: balance sheets were incomplete, and comparability was compromised.

The Research Impetus

Research by standard-setters showed that off-balance-sheet operating leases were massive: some companies' total lease liabilities exceeded their reported debt. Operating leases were the hidden liability of the corporate world.

The New Standards: Broad Convergence, Key Differences

Both ASC 842 and GASB 87 moved to a model where most leases are capitalized. Both require recognizing a right-of-use (ROU) asset and a lease liability. But the similarities end there.

ASC 842: The Single Model (Private Sector)

ASC 842 (FASB, effective 2019 for public companies; 2021 for private companies) establishes a single model for all leases:

All leases (except those meeting short-term exceptions) result in:

Recognition of a right-of-use asset
Recognition of a lease liability
Lease expense on the income statement

The distinction is now presentation, not recognition:

Classification	Asset	Liability	Expense	Balance Sheet Presentation
Finance Lease	ROU Asset	Lease Liability	Depreciation + Interest	Debt-like
Operating Lease	ROU Asset	Lease Liability	Straight-line rental	Operating-like

Both are on the balance sheet. Operating leases show less "interest" component and more "amortization" component, but both are capitalized.

GASB 87: The Dual Model (Government)

GASB 87 (GASB, effective for fiscal years ending after June 15, 2021) introduces a dual model:

Short-term leases (12 months or less) remain off-balance-sheet; rent expense only
Long-term leases (>12 months) are capitalized with ROU asset and liability

Additionally, GASB 87 includes a regulated lease exception: certain leases of regulated utilities in a rate-regulated environment are exempted from capitalization if the regulator has incorporated the lease into rate-setting.

Key Provision: Leases ≤12 Months Stay Off the Balance Sheet

A government leasing office equipment for 1 year recognizes $12,000 in annual rent expense and does not capitalize a lease liability or ROU asset. A private company under ASC 842 would likely capitalize even a 1-year lease (unless it qualifies as short-term, which ASC 842 defines differently).

Discount Rate: The Core Mechanical Difference

The discount rate used to calculate the present value of lease payments is a critical driver of the lease liability size. The two standards diverge meaningfully here.

ASC 842: Incremental Borrowing Rate (IBR) as Primary Method

ASC 842 requires using the lessee's incremental borrowing rate (IBR) in most cases. The IBR is the rate the company would incur borrowing similar amounts over a similar term in the same economic environment.

Guidance: If the lease does not explicitly state a rate, the lessee uses its IBR. A company calculates its IBR by adjusting its own borrowing rate for the nature of the lease collateral (e.g., a secured equipment loan rate vs. unsecured corporate rate).

Illustration: A retail company leases store fixtures for 5 years at $100,000 annually. The company's 5-year unsecured borrowing rate is 5%. The lease liability is calculated as the present value of $100,000/year at 5%:

PV = $100,000 × [4.329] (PVAF at 5%, 5 years) = $432,900
Lease Liability (initial) = $432,900

GASB 87: Risk-Free Rate as Default

GASB 87 requires using the risk-free rate (typically the yield on U.S. Treasury securities matching the lease term) unless the lease includes an implicit rate.

Guidance: Governments typically lack published incremental borrowing rates (unlike corporations). GASB 87 sidesteps this problem by defaulting to the risk-free rate. If the lease explicitly states a rate (e.g., "interest shall accrue at 3%"), the government uses the explicit rate.

Illustration (Same Example): A government leases office equipment for 5 years at $100,000 annually. The 5-year U.S. Treasury rate is 3%. The lease liability is:

PV = $100,000 × [4.580] (PVAF at 3%, 5 years) = $458,000
Lease Liability (initial) = $458,000

Why It Matters

The discount rate directly drives the lease liability size. The lower the rate, the higher the present value. A government using 3% (risk-free) will report a larger lease liability than a corporation using 5% (IBR). This is not a small difference:

Company (5% IBR):      $432,900 liability
Government (3% risk-free): $458,000 liability
Difference:            $25,100 (5.8% higher for government)

Over time, compound interest effects amplify this difference. The government's larger initial liability results in higher interest expense in early years and higher depreciation (if the ROU asset is depreciated).

Operating Lease Treatment: Single Model vs. Dual Model

ASC 842 (Private Sector): Operating Leases Are On the Balance Sheet

Under ASC 842, an operating lease results in:

ROU asset on the balance sheet
Lease liability on the balance sheet
Straight-line rent expense (similar to operating rent under the old standard)

Journal Entries—Finance Lease (5-year, $100,000/year, 5% IBR):

Inception:

Dr. Right-of-Use Asset                 $432,900
    Cr. Lease Liability                              $432,900

Year 1:

Dr. Rent Expense                        $21,645
Dr. Interest Expense                     $21,645
    Cr. Cash                                       $100,000

Year 1 (Annual adjustment):

Dr. Depreciation Expense                 $86,580 [$432,900 / 5]
    Cr. Accumulated Depreciation, ROU Asset       $86,580

Journal Entries—Operating Lease (5-year, $100,000/year, 5% IBR):

Inception:

Dr. Right-of-Use Asset                 $432,900
    Cr. Lease Liability                              $432,900

Year 1:

Dr. Rent Expense                        $86,580 [$432,900 / 5]
    Cr. Lease Liability                             $86,580

Dr. Interest Expense                     $21,645 [5% × $432,900]
    Cr. Lease Liability                             $21,645

Dr. Lease Liability (reduction)          $-8,065 [for purposes of cash payment alignment]
    Cr. Cash                                      $100,000

The key: Operating leases produce straight-line rent expense, not front-loaded interest + depreciation.

GASB 87 (Government): Short-Term Leases Remain Off the Balance Sheet

Under GASB 87:

Leases ≤12 months: Rent expense only (no capitalization)
Leases >12 months: ROU asset and liability capitalized

Short-Term Lease (1-year, $12,000):

Dr. Rent Expense                        $12,000
    Cr. Cash                                       $12,000

[No balance sheet recognition]

Long-Term Lease (5-year, $100,000/year, 3% risk-free rate):

Inception:

Dr. Right-of-Use Asset                 $458,000
    Cr. Lease Liability                              $458,000

Year 1:

Dr. Rent Expense (straight-line)        $91,600 [$458,000 / 5]
    Cr. Lease Liability                             $91,600

Dr. Interest Expense                     $13,740 [3% × $458,000]
    Cr. Lease Liability                             $13,740

[Reduction in liability to align with cash payment]
Dr. Lease Liability (reduction)         -$5,340
    Cr. Cash                                      $100,000

Or simplified:

Dr. Lease Expense (all-in)               $86,580
    Cr. Cash                                      $100,000
    Cr. Lease Liability                             $13,420

Comparison: Finance vs. Operating Under ASC 842

Under ASC 842, the only difference between a finance lease and an operating lease is presentation. Both are on the balance sheet with similar journal entries. The tension is resolved by straight-line expense for operating leases (mimicking the old standard) and front-loaded interest + depreciation for finance leases.

Variable Lease Payments

ASC 842 Treatment

ASC 842 includes in the lease liability only payments that are probable. Variable payments (e.g., a percentage of sales for a retail space lease) are typically not included in the initial measurement unless they are in-substance fixed (indexed to a rate like CPI).

Example: A retailer leases space for 5 years at $100,000/year base rent plus 2% of annual sales above $500,000. In year 1, sales are $600,000, so the variable payment is $2,000.

Year 1: Lease payment = $102,000
The $100,000 base is included in the lease liability
The $2,000 variable is recognized as rent expense in year 1 when incurred

If the lease included an escalation clause (e.g., base rent increases by 3% annually), that escalation is included in the initial liability because it is in-substance fixed.

GASB 87 Treatment

GASB 87 similarly excludes variable payments from the lease liability unless they are indexed to a specified rate or index (e.g., CPI). Like ASC 842, variable sales commissions are recognized as expense when incurred.

Difference: GASB 87 provides explicit guidance that amounts paid for services (e.g., common area maintenance in a shopping center) are not part of the lease liability; they are recognized as service expense. ASC 842 similarly excludes services and separates them from the lease.

Regulatory Lease Exception (GASB 87 Only)

GASB 87 includes a regulated lease exception not found in ASC 842. This exception is critical for regulated utilities.

The Regulatory Exception

If a lease is subject to rate regulation (e.g., a utility operating under the authority of a state public utility commission), and the regulator has incorporated the lease into the utility's rate-making mechanism, the utility may elect not to capitalize the lease.

Rationale: Rate regulators often determine how utilities should account for leases, ensuring that lease costs are recovered through rates. If the regulator has explicitly approved the lease and incorporated it into rates, the accounting treatment is set by regulation, not by GASB 87.

Example: A public water utility leases a treatment plant from a private operator under a 10-year lease. The state PUC reviews the lease, approves it, and incorporates the lease cost into the utility's revenue requirement for rate-setting. The utility can elect the regulatory exception and recognize lease expense only (not capitalize the liability).

For Non-Regulated Entities: Most governments do not operate under comprehensive rate regulation and cannot use this exception. A city leasing office space must capitalize the lease; a water utility under PUC oversight may elect not to (if the PUC has approved and incorporated the lease).

Right-of-Use Asset Measurement: Differences and Similarities

ASC 842: Complex Measurement Rules

ASC 842 measures the ROU asset at cost, which includes:

Lease liability (as measured)
Lease payments made on or before the commencement date
Initial direct costs (incremental costs directly attributable to the lease, e.g., leasing commissions, legal fees)
Restoration costs (if the lessee is required to restore the asset to original condition upon return)

Less: Lease incentives received

Formula:

ROU Asset = Lease Liability + Lease Payments (pre-commencement) + Initial Direct Costs + Restoration Costs - Incentives

GASB 87: Simpler Measurement

GASB 87 measures the ROU asset as:

ROU Asset = Lease Liability + Lease Payments (pre-commencement) + Initial Direct Costs

GASB 87 does not explicitly address restoration costs (the assumption is that they are not typical for government leases). GASB 87 also does not reference lease incentives in the same way as ASC 842.

Practical Impact: An ASC 842 company with a $100,000 lease incentive and $5,000 in initial direct costs calculates:

ROU Asset = Lease Liability + $5,000 Lease Incentives - $100,000
            = Less detailed calculation

The incentive reduces the ROU asset.

A government under GASB 87 with the same facts calculates:

ROU Asset = Lease Liability + $5,000

The incentive is not explicitly deducted from the ROU asset; rather, it reduces the lease payments in the first place.

Lessor Accounting: The Asymmetry

ASC 842 Lessor Model

Under ASC 842, the lessor (owner of the asset) also capitalizes the lease, recording:

Lease receivable (present value of future payments)
Residual asset (expected value of asset at lease end)
Lease revenue (similar to interest)
Depreciation on the residual asset (if classified as a finance lease)

For operating leases, the lessor retains the asset on its balance sheet and recognizes rental income as received.

GASB 87 Lessor Model

GASB 87 lessor accounting is less developed. Lessors (governments owning assets leased to others) generally recognize:

Lease receivable and revenue, or
Rental income, depending on classification

Governments are less likely to be lessors (more commonly renters), so this asymmetry is less critical.

Embedded Leases

Both ASC 842 and GASB 87 require identifying and accounting for embedded leases—lease components within larger contracts.

Example: A city enters into a 10-year software licensing agreement that includes:

Software access (service contract)
Use of a dedicated server in the vendor's data center (lease component)

Under both standards, the server usage is identified as a distinct lease component and is subject to lease accounting.

Short-Term Lease Exemption

ASC 842

ASC 842 exempts leases with an expected term of 12 months or less from balance sheet recognition. Expected term includes options the lessee is likely to exercise.

Example: A company leases a copier for 11 months with no renewal option. Lease expense only.

A company leases a parking space for 12 months with a 3-year renewal option that the company is reasonably certain to exercise. Expected term is 3 years (if renewal is probable), so the lease is capitalized.

GASB 87

GASB 87 similarly exempts leases with 12 months or less from balance sheet recognition. The definition is slightly simpler: the lease term must be 12 months or less; options are considered if the lessee is reasonably certain to exercise them.

Practical Difference: The short-term threshold is the same (12 months), but the treatment of renewal options is slightly different. Both standards require judgment in determining whether a renewal is probable/reasonably certain, leading to potential inconsistencies.

Transition and Implementation Challenges

ASC 842 Implementation (2019-2021)

Private companies transitioning to ASC 842 faced significant implementation challenges:

Large lease populations: Companies with hundreds or thousands of leases had to extract data from lease agreements, calculate lease liabilities, and populate balance sheets.
Discount rate complexity: Calculating incremental borrowing rates for diverse lease portfolios proved complex.
System updates: Accounting systems required modification to track and report leases separately.
Restatement decision: Companies could elect to restate prior year comparatives or use a cumulative-effect approach (recognize the adjustment at the beginning of the adoption year without restatement).

Most companies chose the cumulative-effect method to avoid restatement costs.

GASB 87 Implementation (2021+)

Governments faced similar challenges:

Data extraction: Identifying all leases (many governments discovered leases they had not formally documented)
Risk-free rate determination: Using Treasury rates appropriate to the lease term
Regulated lease exception: Determining which leases qualified (and requiring coordination with regulators)
Short-term vs. long-term classification: Applying the 12-month threshold consistently

Additionally, many governments discovered that capitalization of leases resulted in significant increases to reported liabilities. Some communities that believed they had minimal debt discovered lease obligations totaling millions.

Comparison Table: Key Differences

Aspect	ASC 842 (Private)	GASB 87 (Government)
Model	Single (all leases capitalized with presentation distinction)	Dual (≤12 months off-balance-sheet; >12 months capitalized)
Discount Rate	Incremental Borrowing Rate (IBR)	Risk-free rate (unless explicit rate in lease)
Variable Payments	Excluded unless in-substance fixed (indexed)	Excluded unless indexed
ROU Asset Measurement	Includes restoration and incentive reduction	Simplified; less explicit on incentives
Regulatory Exception	None	Yes (regulated lease exception)
Short-Term Exemption	≤12 months expected term	≤12 months lease term
Lessor Accounting	Symmetric (receivable and revenue)	Less developed; rarely applicable
Inception Date	2019 (public); 2021 (private)	2021+ (governments)

Which Is Simpler? The Practical Assessment

ASC 842 Advantage: Consistency

ASC 842's single model eliminates the operating/capital distinction that plagued the old standard. Once a lease is capitalized, the presentation mechanics (straight-line for operating, depreciation + interest for finance) are mechanical and predictable.

GASB 87 Advantage: Short-Term Relief

GASB 87's exemption for leases ≤12 months reduces administrative burden. A government can lease equipment for a year without capitalizing. This provides simplicity for routine lease activity.

GASB 87's risk-free rate is also simpler than calculating an IBR—governments can look up Treasury rates published daily.

Overall Assessment

For large organizations with diverse lease portfolios, ASC 842 is arguably simpler due to its single, consistent model. For governments with mostly short-term leases (vehicles, equipment), GASB 87's exemption provides practical relief.

Neither standard is substantially "simpler" than the other; they represent a trade-off between consistency and administrative burden.

Key Takeaways

Both standards capitalized leases; the approach differs. ASC 842 uses a single model; GASB 87 retains a short-term exemption.
Discount rates diverge. ASC 842 uses the lessee's IBR; GASB 87 defaults to the risk-free rate. This difference drives different lease liability measurements.
Operating leases are now balance sheet items under ASC 842. Under GASB 87, only long-term leases appear; short-term leases remain off-balance-sheet.
The regulatory exception is government-specific. Regulated utilities may elect not to capitalize certain leases if regulators have incorporated them into rate-setting.
Implementation complexity is significant for both. Identifying leases, calculating liabilities, and system updates are non-trivial for organizations with diverse lease populations.
Hybrids and embedded leases require careful analysis. Both standards require identifying lease components within mixed contracts.
Converged but not identical. FASB and GASB intended to converge lease accounting but maintained distinct standards reflecting different stakeholder needs.

For organizations navigating both standards (healthcare systems, public universities with component units), careful tracking of the differences is essential to ensure compliance with both ASC 842 and GASB 87.

This article was prepared with AI-assisted research by DWU Consulting. It is provided for informational purposes only and does not constitute legal, financial, or investment advice. All data should be independently verified before use in any official capacity.