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Lease Accounting Policy

 

West Virginia University Policy
Division of Administration and Finance

Policy Number: IARA-06
LEASE ACCOUNTING POLICY     

General Information

Reason For This Procedure:

To Whom Does This Procedure Apply:  

Definitions


 

Lease

An agreement conveying the right to use property, plant, or equipment (land and/or depreciable assets) usually for a stated period of time.  This definition does not include agreements that are contracts for services that do not transfer the right to use property, plant, or equipment from one contracting party to another.

 

Procedure

Responsibilities

Procedure Development

Implementation

Interpretation

Contacts

Related Documents

Appendix A
Accounting for Leases

Governmental Accounting Standards Board (GASB) Statement No. 62 establishes standards of financial accounting and reporting for leases.  For purposes of this statement, a lease is defined as an agreement conveying the right to use property, plant, or equipment (land and/or depreciable assets) usually for a stated period of time.  This definition does not include agreements that are contracts for services that do not transfer the right to use property, plant, or equipment from one contracting party to another.

See GASB Statement No. 62 for additional guidance, including definitions of terms.  Also see Capitalization Policy and Depreciation Policy.

Criteria for Classification as a Capital Lease - Leases Involving Equipment

If, at its inception, a lease meets one or more of the following four criteria, the lease should be classified as a capital lease.  Otherwise it should be classified as an operating lease.

A.     The lease transfers ownership of the property to the lessee by the end of the lease term

B.     The lease contains a bargain purchase option

C.     The lease term is equal to 75% or more of the estimated economic life of the leased property.  (However, if the beginning of the lease term falls within the last 25% of the total estimated economic life of the leased property, including earlier years of use, this criterion should not be used for purposes of classifying the lease.)

D.    The present value of the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor, equals or exceeds 90% of the fair value of the leased property. 

Swap Out of Equipment:  A substantial physical change to the specified property, plant, or equipment requires a reassessment of the arrangement to determine whether the arrangement contains a lease on a prospective basis. For purposes of determining if a physical change to the specified property, plant, or equipment gives rise to a reassessment, increases or decreases in productive capacity that result from adding or subtracting a physically distinct unit of property, plant, or equipment shall be ignored if fulfillment of the arrangement is dependent upon a distinct unit of property, plant, or equipment that remains unchanged.

Noncancelable Leases

A lease that is cancelable (a) only upon the occurrence of some remote contingency, (b) only with the permission of the lessor, (c) only if the lessee enters into a new lease with the same lessor, or (d) only if the lessee incurs a penalty in such amount that continuation of the lease appears, at inception, reasonably assured shall be considered “noncancelable”.  

Most of WVU’s leases contain a clause that states that WVU may cancel any purchase/order contract upon 30 days written notice to the vendor in addition to a clause that states that continuation of the purchase order/contract is contingent upon funds being appropriated by the Legislature or otherwise being made available.  The likelihood of cancelation or discontinuation of a lease, through exercise of these clauses, is considered to be remote.  Therefore, all of WVU’s leases are considered to be noncancelable for purposes of determining the accounting treatment per GASB Statement No. 62.

Open Ended Leases

A renewal or extension of the arrangement that does not include modification of any of the terms in the original arrangement before the end of the term of the original arrangement shall be evaluated only with respect to the renewal or extension period. The accounting for the remaining term of the original arrangement shall continue without modification. The exercise of a renewal option that was included in the lease term at the inception of the arrangement shall not be considered a renewal for the purpose of reevaluating the arrangement. Accordingly, the exercise of the renewal option shall not trigger a reassessment.

Leases Involving Land Only

If the lease transfers ownership of the property to the lessee by the end of the lease term (A) or if the lease contains a bargain purchase option (B), the lease should be accounted for as a capital lease.  Otherwise, the lease should be accounted for as an operating lease.

Leases Involving Land and Buildings

If the lease transfers ownership of the property to the lessee by the end of the lease term (A) or if the lease contains a bargain purchase option (B), the lease should be accounted for as a capital lease and the land and building should be separately capitalized.  The present value of the minimum lease payments after deducting executory costs should be allocated between land and buildings in proportion to their fair values at the inception of the lease.

If the lease does not transfer ownership, does not contain a bargain purchase option, and if the fair value of the land is less than 25% of the total fair value of the leased property at the inception of the lease, the land and building should be considered as a single unit for purposes of determining if the lease term is equal to 75% or more of the estimated economic life of the leased building (C) or if the present value of the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs, equals or exceeds 90% of the fair value of the leased property.  If either criterion is met, the land and building should be capitalized as a single unit and amortized.  Otherwise, the lease should be accounted for as an operating lease.

If the lease does not transfer ownership, does not contain a bargain purchase option, and if the fair value of the land is 25% or more of the total fair value of the leased property at the inception of the lease, the land and building should be considered separately.  For the building element of the lease, determine if the lease term is equal to 75% or more of the estimated economic life of the leased building (C) or if the present value of the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs, equals or exceeds 90% of the fair value of the leased property.  (The minimum lease payments should be separated by determining the fair value of the land and applying the lessee’s incremental borrowing rate to it to determine the annual minimum lease payments applicable to the land element; the remaining minimum lease payments should be attributed to the building element.)  If either criterion is met for the building element, the lease should be accounted for as a capital lease and the building should be amortized.  The land element should be accounted for separately as an operating lease.  If the building element does not meet either criterion, both the building element and the land element should be accounted for as a single operating lease.

The fair value of the property at the inception of the lease will ordinarily be its cost.  However, when there has been a significant lapse of time between the acquisition of the property by the lessor and the inception of the lease, the determination of fair value should be made in light of market conditions prevailing at the inception of the lease.  There is no requirement to obtain an appraisal or similar valuation.  Estimated replacement cost may be used as a reasonable estimate of fair value.

Leases Involving Equipment as Well as Real Estate

The portion of the minimum lease payments applicable to the equipment portion of the lease should be estimated by whatever means are appropriate.  The equipment should be considered separately for purposes of determining whether the lease should be classified as capital or operating.

Leases Involving Only Part of a Building

When the leased property is part of a larger whole (for example, when an office or floor of a building is leased) and the fair value (ordinarily the cost) is objectively determinable and either the lease transfers ownership of the property to the lessee by the end of the lease term (A) or the lease contains a bargain purchase option (B), the lease should be accounted for as a capital lease.  Otherwise, the lease should be accounted for as an operating lease. 

If the fair value is not objectively determinable and the lease term is equal to 75% or more of the estimated economic life of the leased building (C), the lease should be accounted for as a capital lease.  Otherwise, the lease should be accounted for as an operating lease. 

The fair value of the property at the inception of the lease will ordinarily be its cost.  However, when there has been a significant lapse of time between the acquisition of the property by the lessor and the inception of the lease, the determination of fair value should be made in light of market conditions prevailing at the inception of the lease.  There is no requirement to obtain an appraisal or similar valuation.  The ability to make a reasonable estimate of the leased property’s fair value may vary depending on the size of the leased property in relation to the entire facility.  Estimated replacement cost may be used as a reasonable estimate of fair value. 

Accounting Treatment of Capital Leases

The lessee should record a capital lease as an asset and an obligation at an amount equal to the present value at the beginning of the lease term of minimum lease payments during the lease term, excluding that portion of the payments representing executory costs, such as insurance, maintenance, and taxes, to be paid by the lessor.  The lessee should compute the present value of the minimum lease payments using the incremental borrowing rate (the rate that, at lease inception, the lessee would have incurred to borrow over a similar term the funds necessary to purchase the leased asset). 

Except for leases involving land, the asset recorded under a capital lease should be amortized as follows:

A change in the provisions of a lease, a renewal or extension of an existing lease, and a termination of a lease prior to expiration of the lease term should be accounted for as follows:

Change in Provisions of Lease

Renewal or Extension of an Existing Lease

Termination of a Lease

Interest Rate

Accounting Treatment of Operating Leases

 

Originally Issued: July 1, 2010
Updated: February 8, 2016
Approved by: Daniel A. Durbin, Senior Associate Vice President for Finance