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The effective date for GASB 87, Leases, is fast approaching for state and local governments (effective for fiscal years beginning after June 15, 2021). This article focuses on short-term leases and how they are defined and accounted for under GASB 87.
What is a Short-Term Lease?
GASB 87 defines a short-term lease as “…a lease that, at the commencement of the lease term, has a maximum possible term under the lease contract of 12 months (or less), including any options to extend, regardless of their probability of being exercised.”
Lease Term Calculation and Examples
To determine if the lease can be considered short-term, the maximum possible term must be calculated. A lease term or option that is cancelable by both the lessee and the lessor without permission from the other party (or if both parties agree to extend) is excluded from the maximum possible term. If either the lessee or the lessor can cancel a lease term or option, that period is included in the maximum possible term. For a lease that is cancelable by either the lessee or the lessor, such as a rolling month-to-month lease, the maximum possible term is the noncancelable period, including any notice periods.
- For example, a District (lessee) enters into a lease with a City (lessor) for 18 months. The District can cancel the lease at any time after 6 months. The City does not have the option to cancel the lease. The maximum possible term is 18 months and the lease does not qualify as a short-term lease.
- If both the District and the City had the option to cancel the lease after 6 months, the remaining 12 months would be excluded from the determination of the maximum possible term. Therefore, the maximum possible term would be 6 months and thus would qualify as a short-term lease. However, since only the District has the ability to cancel the lease after 6 months, the maximum possible term is 18 months and this lease does not qualify as a short-term lease.
GASB 87 uses the term reasonably certain, which represents a high level of certainty. To determine if a lease option is reasonably certain of being exercised, the government should consider how options have been handled in the past, the economic impact of the option, and the importance/significance of the underlying asset to operations.
For short-term leases, the concept of reasonably certain does not apply to the calculation of the maximum possible term in the determination of whether the lease is considered a short-term lease; however, it does impact the calculation of the lease term when recording it in the financial statements as described in the following example.
- A Town enters into a 6-month noncancellable lease with a 12-month option to extend. The Town can cancel the lease any time after 6 months without the permission of the lessor. The maximum possible term equals 18 months and would not qualify as a short-term lease.
- If the Town was not reasonably certain that the 12 month-option to extend would be exercised, the lease term to be recorded in the financial statements would be 6 months and the lessee would record a lease liability and a lease asset.
In summary, a short-term lease will be analyzed twice; first, to calculate the maximum possible term to determine if it is a short-term lease; and secondly, to determine the lease term to be recorded in the financial statements.
Recording a Short-Term Lease
A lessee should recognize short-term lease payments as outflows of resources (expense) based on the payment provisions of the lease contract. The lessee should recognize an asset if payments are made in advance or a liability for rent due if payments are to be made subsequent to the reporting period.
A lessor should recognize short-term lease payments as inflows of resources (revenue) based on the payment provisions of the lease contract. Additionally, the lessor should recognize a liability if payments are received in advance of an asset for rent due if payments are to be received subsequent to the reporting period.
Stay tuned for a new article each month to assist with the implementation of GASB 87 and contact our trusted advisors to learn more or discuss your specific situation today.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.