In recent years, the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB) have updated their lease accounting standards to enhance transparency and comparability in financial reporting. These updates, ASC 842 and GASB 87 represent significant changes from previous standards. Understanding the differences between these standards is essential for private companies and public entities. Here, we’ll delve into the key distinctions between ASC 842 and GASB 87, focusing on scope, recognition, measurement, and disclosure requirements.
Scope of ASC 842 and GASB 87
ASC 842
ASC 842 applies to all entities that follow Generally Accepted Accounting Principles (GAAP) in the United States. This includes public and private companies, as well as nonprofit organizations. The primary goal of ASC 842 is to ensure that all leased assets and liabilities are recorded on the balance sheet, providing a more accurate representation of an entity’s financial position.
GASB 87
GASB 87 is designed specifically for governmental entities, including state and local governments. Like ASC 842, GASB 87 aims to improve the transparency and comparability of lease transactions in financial reports. However, it is tailored to the unique environment and accounting practices of public sector organizations.
Recognition and Measurement
ASC 842
Under ASC 842, leases are classified into two categories: finance leases and operating leases.
- Finance Leases: These are treated similarly to capital leases under the previous standard (ASC 840). They require the lessee to recognize a right-of-use (ROU) asset and a lease liability on the balance sheet.
- The asset is depreciated, and the liability is amortized over the lease term, resulting in interest and amortization expenses on the income statement.
- Operating Leases: These leases also require the recognition of an ROU asset and lease liability. However, the expense is recorded as a single lease cost, typically on a straight-line basis over the lease term, which differs from the dual expense recognition of finance leases.
GASB 87
GASB 87 eliminates the distinction between operating and capital leases. Instead, all leases are treated as finance leases. This means governmental entities must recognize a lease asset (an intangible right-to-use asset) and a corresponding lease liability. The lease asset is amortized, and interest expense is recognized on the liability, similar to finance leases under ASC 842.
Key Differences in Measurement
Initial Measurement
Both standards require the initial measurement of the lease liability to be the present value of lease payments, but there are some differences in the details. ASC 842 allows the use of the rate implicit in the lease or the lessee’s incremental borrowing rate if the implicit rate is not readily determinable. GASB 87, however, emphasizes using the interest rate charged by the lessor, or the lessee’s estimated incremental borrowing rate if the lessor’s rate is not available.
Subsequent Measurement
Under ASC 842, the subsequent measurement of the lease liability for finance leases involves recognizing interest on the lease liability and reducing the liability by lease payments. For operating leases, the liability is reduced by lease payments without recognizing interest separately. GASB 87, with its single lease model, requires the lease liability to be reduced by lease payments and the leased asset to be amortized over the lease term.
Disclosure Requirements
ASC 842
ASC 842 requires extensive disclosures to provide financial statement users with sufficient information to understand the amount, timing, and uncertainty of cash flows arising from leases. These include qualitative and quantitative details about lease terms, variable lease payments, options to extend or terminate leases, and the nature of lease arrangements.
GASB 87
Similarly, GASB 87 mandates disclosures that offer insights into governmental entities’ lease obligations. Required disclosures include a description of leasing arrangements, the total amount of lease assets and liabilities, the amount of lease expense recognized during the period, and the maturity analysis of lease liabilities.
Implementation Considerations
ASC 842
Entities adopting ASC 842 must ensure their accounting systems and processes can handle the new recognition and measurement requirements. This may involve significant changes to lease management systems, staff training, and software tools to accurately track and report lease data.
GASB 87
Governmental entities implementing GASB 87 must similarly update their accounting systems and procedures to comply with the new standard. Given the nature of governmental leases, which can include various assets, careful planning and coordination across departments are essential for a smooth transition.
Practical Implications for Entities
Private Companies and Nonprofits
For entities under ASC 842, the distinction between finance and operating leases means they must carefully analyze each lease agreement to determine the appropriate classification. This process can be time-consuming and may require detailed reviews of lease contracts.
Governmental Entities
Under GASB 87, eliminating the operating lease category simplifies lease classification but requires detailed tracking of all lease agreements. Governmental entities must ensure they have systems to measure and report lease liabilities and assets accurately.
By understanding these distinctions, entities can better navigate lease accounting complexities and ensure compliance with the appropriate standards. Both ASC 842 and GASB 87 aim to provide clearer financial insights, though their approaches differ to suit the needs of their respective sectors.
Leveraging Software to Managing Lease Accounting Compliance
Whether you’re dealing with ASC 842 or GASB 87, you want to avoid managing accounting through spreadsheets. Instead consider software to track deadlines, lease agreements, lease updates, and your entire lease portfolio. When you’re in the market for lease accounting software, head over to G2 or Capterra to find a list of available vendors. Schedule demos and ask plenty of questions before your organization implements any type of lease management software
