Introduction

In June 2017, the Government Accounting Standards Board (GASB) issued Statement No. 87, Leases. GASB Statement No. 87 (GASB 87) increases the usefulness of governmental financial statements by requiring recognition of certain lease assets and liabilities, including those that previously were classified as operating leases and recognized as revenue by lessors and expenditures by lessees. These requirements go into effect in 2022.

Lease Terminology

Conveys Control: as specified in contract, must both have right to underlying assets:

• Present service capacity from use of the asset

• Determine nature and manner of use (right to direct how and for what purpose)

Exchange or Exchange-Like Transaction– when each party receives and gives up essentially equal values for the property being leased or sold.

Lease - contract that conveys control of the right to use (ROU) another entity’s nonfinancial asset (the underlying asset – building, land, infrastructure, and/or equipment) as specified in the contract for a period in an exchange or exchange-like transaction.

Lease Extension – a continuation of the original lease agreement (not a lease renewal)

Lease Incentive – an inducement for a lessee to sign a lease (i.e., lessor agrees to take over remaining lease payments on existing lease(s), pay moving costs, or make cash payments to the lessee).

Lease-leaseback Transaction – Leased asset by one party to another party and then leased back to the first party (i.e., Developer constructed a building on County owned land. The constructed building is leased back to the County.)

Lease Renewal – a new lease agreement (not a lease extension)

Lessee – a person (or entity) who holds the lease of a property; For example, the County is a tenant or rents a copier.

Lessor – a person (or entity) who leases or lets property to another

Lease Term – The noncancelable period during which a lessee has a right to use a capital asset, plus periods covered by a lessee’s or lessor’s option to extend or terminate, if reasonably certain the option will be exercised, or termination will not be exercised.

Max Term – The noncancelable term plus all optional extensions regardless of probability to exercise extension options. Term used to identify short-term from longterm leases.

Noncancelable period – period which neither the lessor/lessee has right to terminate the lease OR only the lessor has the right to terminate. (Conversely cancelable period –both lessor or lessee has right to terminate the lease without permission from other party, such as a rolling month to month lease.)

Non-Lease Component – A distinct element of a contract not related to securing the use of the asset.

Purchase Option – right without obligation to purchase a leased asset at a certain price within a certain time period.

Residual Value Guarantees – amount to be paid by the County to a lessor at the end of the lease term.

Right of Use (ROU) - The right to use a nonfinancial (capital) asset.

Sale-leaseback Transaction – County asset sold to a third party (buyer), then the asset is leased back to the County by the buyer.

Short Term Lease – a lease with a maximum possible lease term of 12 months or less, including any options to extend, regardless of probability to exercise extension options.

Sublease – County leases an asset to a third party the County is currently leasing as a lessee.

Exceptions/Exclusions

The following are exclusions or exceptions to GASB 87 requirements or Pierce County adopted policies.

• Short-term leases – Leases that have at the commencement of the lease, a maximum possible term of 12 months. The term includes the stated noncancelable periods plus any extensions regardless of probability of extending. Examples: o Rolling month to month leases and leases that continue into a holdover period until a new lease contract is signed. o Leases where both the lessee and lessor have the option to terminate without permission (such as with 30- or 60-days’ notice) from the other party.

• Contract threshold exclusions: o Land, Building, and Infrastructure: Right of Use Assets total contract less than $75,000 o Equipment: Lease term less than 5 years AND annual payment less than $10,000

• Leases where payment is less than fair market value (i.e., $1 monthly payment or payment is less than 80% of what could be collected to rent or lease asset at fair market value)

• Interfund Leases – Leases between departments or funds within the same government

• Intangible assets – Such as mineral rights, patents, software, copyrights. Except for the sublease of an intangible right to use asset created by the original lease of the tangible underlying asset.

• Biological assets – Such as timber, living plants, living animals.

• Lease of Inventory - This includes items purchased for resell or consumption within the county. Note: if the item is on the annual Supply Inventory Report it is considered Inventory.

• Service Concession arrangements – County allows an operator to provide a public service using County owned assets. The operator collects and is compensated by fees. The County determines services and fees to be collected. Assets commonly used in SCAs: roads, bridges, water and sewer, parking garages, golf courses, etc.

• Assets financed with outstanding conduit debt – Unless both the asset and conduit debt are reported by the lessor (ex. Revenue Bonds or Debt for Capital Financing)

• Supply contracts – Such as power purchase agreements.

• Certain regulated leases – Such as aviation lease between airports and air carriers.

Leases Agreements

Types of Leases

Right of Use Lease: A contract that conveys control of the right to use another entity’s nonfinancial asset* (the underlying asset) as specified in the contract for a period of time in an exchange or exchange like transaction.”

A contract conveys control when the County has the right to:

1. Direct how and for what the purpose the asset is used AND

2. Obtain substantially all the economic benefits from the asset.

* Examples of nonfinancial assets include buildings, land, infrastructure, and equipment.

Financed Purchase Agreement: A contract that transfers ownership of underlying asset to the County by the end of the contract and does not contain termination options.

Lease Term

Stated noncancelable lease period

Optional renewal periods if lessee is reasonably certain to exercise

Renewal Periods should be excluded where both the lessee and the lessor have an option to terminate without the permission from the other party. However, if only one party has the option to cancel, those periods should be included in the lease term.

Reasonably Certain – The lessee has a compelling economic reason to exercise the renewal or purchase option, or to not exercise a termination option. Consider all factors relevant to the assessment:

• Market based factors: Are you currently getting a good deal? If the terms of your current contract are better than the market conditions, then you will probably choose to renew your current contract if you have the option.

• Contract based factors: The cost to terminate the current lease and sign a new lease, which may include cancellation penalties, negotiation costs, relocation costs, and leasehold improvements.

• Asset-based factors: How essential is the asset to providing services – can you afford to not be able to use the asset, even for just a short period of time?

• Government specific factors: Consider your history of exercising options to extend or terminate leases. If the County typically remains in the same building for 20 or more year, it is reasonably certain that the County would exercise the option to renew a 10-year lease for an additional 10 years.

Interest Rates

If the lease term is longer than one budget period (i.e. biennium) in duration, advance approval by Finance, Executive and Council is required.

The lease rate is defined as the interest rate associated with leasing the asset during the lease period and can also be considered as the compensating amount which otherwise the lender would have earned if the same property/equipment/vehicle had been put in some other use. There are three types of interest rates associated with lease agreements.

Explicit Interest Rate – An Explicit Interest Rate is a rate clearly stated in the contract. Whenever possible, use the Explicit Interest Rate.

Implicit Interest Rate – An Implicit Interest Rate is a rate calculated using the following three pieces of information: the number of payments, the payment amount and the value of the asset (average price to buy if purchased). The Implicit Interest Rate should be used when the rate is not explicitly stated in the contract. If you are unable to obtain those three pieces of information and no explicit rate is stated in the contract, the Current Incremental Borrowing Rate should be used.

Implicit Rate Calculator Tool

Incremental Borrowing Rate – The Incremental Borrowing Rate is an estimate of the rate of interest that would be charged for borrowing the lease payment amounts during the least term. It should be used when the Explicit Rate is not stated in the contract and the necessary information used to calculate the Implicit Rate is unavailable.

Incremental Borrowing Rate website

Initial Direct Costs

An Initial direct cost is defined as the “incremental costs of a lease that would not have been incurred had the lease not been obtained.” They are ancillary costs incurred by the County that were necessary to place the asset in service.

For example, the County pays $2,000 for delivery and installation of the equipment being leased. Another example is cost incurred to reconfigure a space for the leased asset.

Costs excluded from initial direct costs, are any cost that would have been incurred even if the lease contract failed to execute. For example, costs (directly or indirectly) attributed to negotiating/drafting/etc. for the lease are not considered initial direct costs.

Lease Incentives

Lease incentives are enticements lessors provide to encourage lessees to sign a lease. Payments / reimbursements made by a lessor to a lessee associated with lease.

For example, cash payments to the County from the lessor: Tenant Improvement Allowances given by lessor used by the County to improve space; Lessor “buying out” or “taking over” the lessee’s previous lease; Moving expense reimbursements.

Multiple ROU Assets

A lease may include more than one ROU Asset. When a lease includes multiple Right of Use Assets, the department should attempt to identify the individual cost of each ROU asset.

Example: A lease that includes an office building and parking lot.

Total Contract Amount

All costs associated with a lease must be included in the Total Contract Amount entered in Workday. The associated costs could be explicitly stated in the contract but may be included without a stated value.

If the contract runs out of funds during the term of the contract, the contract will likely have to be canceled and a new contract entered. A contract may only be amended to account for payment changes or an extension.

The Negotiator Checklist calculates the Total Contract Amount to be entered in Workday.

The Total Contract Amount will include:

• Lease Payments – Fixed or Variable Payments as stated in contract to lease asset including extension if reasonably certain to be exercised.

• Termination Penalties – include if termination option reasonably certain to be exercised

• Purchase Option/Residual Value Guarantees – if reasonably certain to be exercised

• Initial Direct Costs payable to the Supplier

• Usage Payments – dependent on usage of asset (# of copies, miles, hours, etc.)

• Non-Lease Components/Other Payments - services, common area maintenance, utilities, property taxes, sales tax, etc.

If a contract does not include amounts for items above, an estimate should be used to allocate the contract price to those components.

If non-lease components cannot be separated from the lease components, they should be included in the lease payment.