In June 2017, the Governmental Accounting Standards Board (GASB) issued Statement Number 87, Leases, significantly changing the accounting and reporting requirements for lease arrangements.
What It Does
The new standard defines a lease as “a contract that conveys control of the right to use another entity’s nonfinancial asset . . . for a period of time.” This includes traditional lease items—such as land, buildings, equipment, and vehicles—and may also include lease arrangements previously accounted for as operating leases, including certain casino gaming machine contracts.
For items that fall under the new lease definition, lessees will recognize a lease asset and liability at the inception of the lease agreement while lessors will recognize a lease receivable and a deferred inflow of resources.
The resulting lease assets and liabilities are generally to be recorded at the present value of payments expected to be made during the lease term—adjusted for certain incentives and direct costs as outlined in the standard.
The standard is effective for reporting periods beginning after December 15, 2019, which means it’ll be effective in 2020 for calendar-year reporters. It requires its provisions be applied retroactively by restating financial statements, if practicable, for all prior periods presented.
This means a tribal entity planning to issue comparative 2020–2019 financial statements will need to be prepared to determine the necessary journal entries for the 2019 calendar year as well.
In addition to the increased level of accounting work needed to record and track lease arrangements, one of the more significant items the new standard will potentially impact is debt-covenant compliance—particularly for casinos.
Most casino debt agreements include financial covenants requiring the maintenance of certain leverage and fixed charge ratios, which are in turn driven by the casino’s long-term debt balances and earnings before interest, tax, depreciation, and amortization—also known as EBITDA.
For example, if a casino determines some of its gaming machine agreements qualify for lease accounting under the new standard, both long-term liabilities and EBITDA would be impacted. Long-term liabilities would increase, as would EBITDA, because lease expenses previously classified as operating expenses would instead be charged to amortization and interest expense.
Additionally, because many casino debt agreements bear interest at adjustable rates that periodically reset depending on the casino’s leverage ratio, the underlying debt pricing could be impacted.
To help lessen any potentially negative impact, casinos will want to communicate with lenders to ensure both parties understand how the new lease accounting standard may affect their financial covenants and interest rates.
The standard doesn’t apply to all lease arrangements. Some of the more noteworthy exceptions include the following:
- Leases of intangible assets
- Short-term leases
- Leases that call for variable payments based on future performance of the lessee or usage of the underlying asset
Leases of Intangible Assets
Examples of leases of intangible assets might include gaming machine use rights or terminal allocation agreements—both of which are applicable in certain jurisdictions. In Washington, for example, each tribe is allotted a certain number of gaming machine use rights. Many tribes lease all or a portion of their gaming machine allocation to other tribes.
Because these arrangements involve leasing the right to use an allotment instead of the underlying physical machines themselves, they would be subject to existing standards for intangible assets and wouldn’t be affected by the new lease accounting standard.
Short-term leases are defined as leases that, at the commencement of the lease term, have a maximum possible term of 12 months or less. Short-term leases should be expensed as incurred.
Leases with Variable Payments
Gaming machine agreements that call for lease payments strictly based on the level of future revenues earned through participation agreements—also known as revenue-share agreements—would be expensed as incurred because they’re based on future performance of the underlying asset.
Many participation agreements also include provisions for a minimum charge due to the vendor, however, prompting the performance of an analysis of the base charge. The result of this analysis may require the lease to be accounted for under the new standard.
How Tribal Organizations Can Prepare
Perform an Inventory of Lease Agreements
Identify all contracts that might qualify as a lease under the new guidance and summarize their terms. This can quickly become a more complicated and challenging process than anticipated—especially for tribal casinos, which frequently enter into a large number of lease and service arrangements.
Understand Contracts with Multiple Elements
Many business contracts—particularly service arrangements—cover multiple elements, which provide for the use of a physical asset as well as related maintenance or supply provisions. The extent to which those multiple elements are clearly identified and quantified within the contracts can vary greatly. It’ll be necessary to gain an understanding of all of the involved elements to properly account for such agreements.
Consider All Lease and Service-Type Arrangements
It’s important to consider all lease and service-type arrangements while performing an inventory. For example, contracts for the following items often include terms that may warrant lease treatment:
- Computer servers and other computer equipment
- Vending machines
The standard indicates its provisions don’t need to be applied to immaterial items; however, entities will need to perform an inventory to quantify the total population of potential leases before deeming an arrangement immaterial.
Because of the time-consuming nature of this step, it’s recommended tribal organizations begin the inventory process now.
Summarize Lease Terms
Summarizing the various leases identified during the inventory requires detailed accounting records that include information about the following:
- Payment schedules
- Discounting of future payments
- Projected depreciation on the potential capital assets
- Amortization schedules for potential liabilities
One of the key provisions to document is the lease term itself, which is defined as the sum of the following two components:
- Period during which a lessee has a noncancelable right to use the underlying asset
- Periods covered by a lessee or lessor’s option to extend the lease if it’s reasonably certain they’ll exercise that option
Spreadsheets may suffice for smaller organizations, but the sheer volume of information larger organizations have to track may make the use of spreadsheets a complicated proposition—including an increased opportunity for input or formula errors. To help ensure efficient and accurate recordkeeping, some entities may want to explore more advanced technology solutions.
Consider Intra-Entity and Related-Party Leases
Tribes often lease land or buildings between various entities within the tribe. Tribes will want to carefully analyze these lease arrangements to ensure proper accounting and reporting—especially given accounting treatment for these leases will vary depending on whether the component units involved are blended or discretely presented.
For example, land leases can have a particularly significant impact on the statement of net position for both lessor and lessee. This is because they frequently have long terms that include renewal options, and the resulting present value of future payments is often substantial.
Establish Entity-Wide Game Plan
Because the management of lease-type arrangements is often decentralized, it may benefit tribal organizations that engage in significant lease activity to hold meetings or trainings to help ensure appropriate team members are aware of the implications of future lease terms.
For example, some casinos may have gaming machine arrangements that meet the new definition of a lease—in turn impacting their debt covenant compliance. At many casinos, these arrangements are frequently negotiated by gaming machine department personnel with little or no involvement from accounting personnel.
Management may want to implement policies and procedures that help ensure all parties communicate about potential lease agreements before they’re finalized, mitigating unwanted or unfavorable accounting consequences. These may include further discussion around decisions to buy or lease underlying equipment or whether lease terms can be negotiated in a more favorable manner.
We’re Here to Help
For more information about how the new lease-accounting standard will affect your tribal entity, contact your Moss Adams professional.