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OUS Fiscal Policy Manual
Accounting and Financial Reporting

OUS » Controller's Division » Policies » OUS Fiscal Policy Manual » Accounting and Financial Reporting
Section: Accounting and Financial Reporting Number:  05.281    
Title: Accounting for Leases

 

This policy is currently being considered for update(s) and is under System-wide review. Draft revisions are indicated in red. For further information, see Policies Pending Review and Comment .

 

Index

POLICY

APPENDIX

.700 ACCOUNTING ENTRIES

POLICY

.100 POLICY STATEMENT 

This policy sets forth certain basic system-wide standards for financial accounting and reporting of leases.  

.110 POLICY RATIONALE

OUS seeks to ensure that the policies and procedures related to financial accounting and reporting of leases are documented, communicated, clearly understood, and consistently applied. 

.120 AUTHORITY

.130 APPROVAL AND EFFECTIVE DATE OF POLICY

Approved by the Associate Vice Chancellor for Finance & Administration/Controller, effective March 9, 2007. 

.140 KNOWLEDGE OF THIS POLICY

All institutional and Chancellor's Office personnel with financial management responsibilities and accounting and financial reporting responsibilities related to leases should be knowledgeable of this policy.

.150 DEFINITIONS

Bargain Purchase Option - An option in a capital lease that allows the lessee to purchase the asset at the end of the lease for an amount that is significantly lower than the expected fair value at the end of the lease.

Capital Lease - A lease of personal or real property which is non-cancelable, one or more of the four capitalization criteria in section .200A of this policy, and meets or exceeds the $5,000 capitalization threshold at the inception of the lease.

Executory Costs - Insurance, maintenance and tax expenses related to a capital or operating lease.

Fair Market Value (FMV) - The price at which two unrelated and non-desperate parties agree to a transaction. Also referred to as an "arms length transaction."

Guaranteed Residual Value - 1) The certain or determinable amount the lessor has the right to require the lessee to pay to purchase the asset or 2) the amount the lessee or the third-party guarantor guarantees the lessor will realize at the end of the lease.

Inception Date - Date of the lease agreement.

Lease - A legal contract by which one party gives to another the use and possession of real or personal property for a specified time in exchange for periodic payments. Differentiated from rent because the time-period of the lease is specific and the amount of the periodic payment is not subject to change during the period of the lease.

Lease Term - The lease term includes the non-cancelable term of the lease, plus the following:

  • All periods covered by bargain renewal options
  • All periods for which failure to renew the lease imposes a penalty on the lessee
  • All periods covered by ordinary renewal options during which the lessee guarantees the lessor's debt on the leased property
  • All periods covered by ordinary renewals or extensions up to the date a bargain purchase option is exercisable
  • All periods representing renewals or extensions of the lease at the lessor's option

Leasehold Improvements - Permanent additions or improvements made to a leased asset that reverts to the owner of the property upon termination of the lease.

Lessee - The party who leases personal or real property from a lessor.

Lessor - The owner of the personal or real property that is leased to a lessor.

Minimum Lease Payments - Amount used to determine if the present value (PV) of rental and other minimum lease payments equals or exceeds 90% of the fair value of the leased property. If the lease contains a bargain purchase option, minimum lease payments include only the minimum rental payments over the lease term and the payment called for in the bargain purchase option. Otherwise, minimum lease payments include the following:

  • Minimum rental payments called for by the lease over the lease term
  • Any guarantee of residual value at the expiration of the lease term
  • Payments that the lessee must or can be required to make upon failure to renew or extend the lease at the expiration of the lease term

Non-cancelable - Terms of the lease make the possibility of cancellation by the lessee remote.1

Operating Lease - A lease of personal or real property that does not meet any of the criteria for a capital lease.

Present Value (PV) - The current value of future cash payments, discounted at the appropriate interest rate.

Rent - Periodic payments made in exchange for use of real or personal property. Differentiated from a lease because the time period of the rental agreement is not specific and the amount of the periodic payment is subject to change.

Residual Value - The price at which a fixed asset is expected to be sold at the end of its service life. Residual value is also referred to as salvage or scrap value.

Sale and Leaseback - Occurs when the institution legally sells an asset and then enters into a lease agreement to lease the asset back.

Service Life - Length of time an asset is expected to last. Service life is used to calculate annual depreciation expense and is dictated by the applicable asset type in Banner Fixed Assets.

Unguaranteed Residual Value - The estimated residual value exclusive of any guaranteed portion.

_________________
1Leases pertaining to governments often have a cancellation ("non-appropriation") clause for circumstances in which the lease would be cancelable if the legislature or other funding authority does not appropriate the funds necessary for the governmental unit to fulfill its obligations under the lease agreements. If this occurrence is considered a "remote contingency," the lease should be considered non-cancelable.

.160 RESPONSIBILITIES

Responsibilities related to accounting for leases include the following: 

A. CHANCELLOR'S OFFICE
  • Developing accounting and reporting policies related to leases.
  • Reporting lease disclosures in financial statements.
B. INSTITUTIONS
  • Determining correct classification of capital versus operating lease.
  • Recording leases correctly in Banner FIS and Fixed Assets.
  • Completing and submitting required year-end reports to the Controller's Division
.200 UNIVERSITY AS LESSEE

A. CRITERIA FOR CAPITAL VS OPERATING LEASE

In general, a capital lease transfers the risks and benefits of ownership to the lessee either through actual title transfer at the end of the lease or because the lease covers a significant portion of the expected life of the asset. Operating leases are generally for substantially less than the expected life of the asset and/or contain cancellation clauses so that the institution is not committed to a long term payment stream.

For financial accounting and reporting purposes, the lease is a "capital lease" if:

  1. the fair market value of the property at the inception of the lease meets or exceeds the capitalization threshold of $5,000,
  2. the lease is non-cancelable, and
  3. the lease meets one or more of the following four criteria:
    1. The lease transfers ownership of the property to the lessee by the end of the lease term.
    2. The lease contains a bargain purchase option.
    3. The lease term is equal to or greater than 75% of the estimated service life of the leased property (e.g., lease is six years, estimated life is eight year.)
    4. The present value (PV) of rental and other minimum lease payments equals or exceeds 90% of the fair value of the leased property less any investment tax credit retained by the lesser (e.g., PV of future minimum lease payments is $9,000, fair value of property is $10,000.) The interest rate used to determine the PV should be the financing rate disclosed in the lease agreement.

If a lease does not meet any of the above criteria, it should be treated as an operating lease.

B. CAPITAL LEASE AUTHORIZATION

A capital lease is essentially a financing arrangement for the acquisition of personal or real property. ORS 283.085 to 283.092 requires approval of the Department of Administrative Services for financing arrangements in excess of $100,000.

C. REAL ESTATE LEASES

LAND ONLY

Leases involving only land are capitalized if either criteria 1 or 2 above are met. If neither of those criteria is met, the lease is classified as an operating lease. The more restrictive criteria are due to the non-depreciable nature of land.

LAND AND BUILDING

When a lease includes land and building, the capitalization criteria is more complicated. If criteria 1 or 2 above are met, the entire lease is capitalized. However, the land and building must be capitalized separately. The present value of the minimum lease payments is allocated between the land and the building in proportion to their fair market values (FMV) at the inception of the lease. The FMV must be determined by the university based on an appraisal and/or the leasing contract.

If neither criteria 1 or 2 are met, an allocation is made between land and building based on relative fair values before applying criteria 3 and 4. If the fair value of the land component is less than 25% of the total, the total value of the lease is treated as entirely applicable to the building. If either criteria 3 or 4 are met, the entire lease is capitalized.

If the land component is 25% or greater, the land and building are treated separately. The land portion is accounted for as an operating lease. Criteria 3 and 4 are applied to the building based on the portion of the lease allocated to the building. If either criterion is met, the building portion is accounted for as a capital lease. If neither criteria 3 or 4 is met, the entire lease is accounted for as an operating lease.

D. ACCOUNTING FOR A CAPITAL LEASE

Capital leases are considered a form of debt financing and must be accounted for as such.

Capital leases are to be recorded in Banner Fixed Assets and FIS. In Banner Fixed Assets, the amount to be recorded upon signing the lease is the present value at the beginning of the lease term of the minimum lease payments during the lease term, or the fair value of the leased property, whichever is less. The leased property cannot be recorded at more than its fair value. Executory costs are not included for purposes of calculating minimum lease payments.

The leased asset is then to be depreciated over the life of the asset as determined from the asset type in Banner Fixed Assets or over the term of the lease:

  • If the capital lease is likely to result in transfer of ownership to OUS (e.g., meets criteria of either transferring ownership or contains a bargain purchase option), then the asset is depreciated over the estimated useful life of the leased property, as determined from the asset type in Banner Fixed Assets.
  • If the capital lease will not result in a transfer of ownership to OUS, the lease is amortized over the lesser of lease term or the estimated useful life as determined from the asset type in Banner Fixed Assets.
  • A capital lease for which we do not expect to obtain ownership should technically not be amortized below its guaranteed residual value (the asset’s expected value at the end of the lease per the terms of the lease agreement). However, accommodating this requirement would conflict with OUS’s general depreciation policy of no salvage value. Given that few capital leases entered into by OUS, if any, contain guaranteed residual values, OUS accounting policy is not to consider salvage value in the amortization of capital leases.

The same amount recorded in Banner Fixed Assets must also be recorded in Banner FIS as an asset, with an offsetting liability for capital lease payments due. As lease payments are made during the year, principal, interest and executory costs need to be separated out using the effective interest method for allocating between the interest expense and payment of capital lease liability. The principal, interest and executory costs should be charged to the appropriate operating ledger expense account codes. At the end of each fiscal year, the capital lease payable liability must be adjusted for the amount of principal paid during the year.

When the lease is complete, if the asset is returned to the lessor, the capital asset and accumulated depreciation need to be removed from the institution's accounting records. If, at the end of the lease, the institution exercises the bargain purchase option or title to the asset is otherwise transferred to the institution, the capital asset and accumulated depreciation should remain on the institution's accounting records.

See Appendix .700 for examples of accounting entries.

E. FINANCIAL REPORTING REQUIREMENTS FOR CAPITAL LEASES

In the notes to the annual financial statements, OUS is required by GAAP to disclose, in total, the capitalized cost of capital leases, and provide a schedule of the future minimum lease payments (excluding executory costs).

To meet these reporting requirements, institutions are required to maintain a debt amortization schedule for each capital lease. The periodic lease payments are to be divided between the lease obligation, executory costs and interest as determined by the amortization schedule.

At fiscal year-end institutions are required to submit two schedules to the Chancellor's Office Controller's Division: a Capital Lease Liability schedule (FS.2.b) of debt amortization for each capital lease and a Capitalized Lease Asset schedule (FS.2.c) of the capitalized cost and accumulated depreciation of capital leases.

Refer to the annual closing of the books instructions for the requested format of the reports.

F. ACCOUNTING FOR AN OPERATING LEASE

No asset and associated liability are created under an operating lease. Operating lease payments are treated strictly as current year expenses and recorded in FIS as such. Operating leased property is not required to be recorded in Banner fixed Assets. An institution may choose to record operating leased property in the Banner Fixed Assets system for insurance coverage purposes. A non-capitalization asset type must be used so that the operating lease is not recorded as an asset in Banner FIS.

An institution may enter into an operating lease with "scheduled rent increases". There are two reasons that the periodic lease payments may increase:

  • Financing Arrangement: The lease payments may be artificially low in the beginning of a lease to induce the lessee to sign the lease. If this is the case, operating lease expense needs to be evenly distributed over the life of the lease based on the straight-line method. An Operating Lease Liability must be accrued during the years of low lease payments. The liability is then decreased during the years of higher lease payments.

  • Economic Reasons: the lease payments may increase due to an increase in the appraised value of the property or because the lease payments are tied to the Consumer Price Index or inflation. If this is the case, payments should be expensed as they are made and there is no need to attempt to calculate or account for future increases before they occur.

See Appendix .700 for examples of accounting entries.

G. FINANCIAL REPORTING REQUIREMENTS FOR OPERATING LEASES

OUS is required by GAAP to disclose total future minimum lease payments relating to the non-cancelable portion of operating leases in the notes to the annual financial statements. To meet these reporting requirement, institutions are required to maintain a schedule of all operating leases and the expected non-cancelable future payments of those operating leases, including any scheduled rent increase, if known. This listing is required to be submitted to the Chancellor's office Controller's Division as a part of the annual closing of the books. Refer to Operating Lease Liability schedule FS.2.a.

The "non-cancelable portion of an operating lease" relates to the time period required for cancellation. If a lease requires one month notice for cancellation, one month's worth of future expense would be reported in the notes to the financial statements at year-end. If a lease requires one year notice for cancellation, 12 months' worth of future expense would be reported in the notes to the financial statements at year-end. If the lease is considered non-cancelable, future expenses for the life of the lease would be reported.

Refer to the annual closing of the books instructions for the requested format of the reports.

H. LEASEHOLD IMPROVEMENTS

Leasehold improvements are permanent additions or improvements made to leased property that revert to the owner of the property upon termination of the lease. Leasehold improvements typically refer to improvements made to buildings or land (real property) that OUS currently occupies through an operating lease. Leasehold improvements of operating leases are assets to OUS but revert to the lessor at the end of the lease.

Leasehold improvements over $5,000 paid for by OUS that last more than one year for which OUS has the right to use during the term of the lease are capitalized and amortized in the Banner FIS accounting records. The asset type for the leasehold improvement is dependent on the nature of the underlying property (e.g., building, land improvements, etc.). If OUS will likely not retain ownership of the leasehold improvement at the conclusion of the lease, the service life of the leasehold improvement is the remaining life of the lease or, the defaulted life of the asset type, whichever is less.

Expenditures for improvements in lieu of lease payments are considered an expense and are not capitalized. Improvements in lieu of lease payments for a period that goes beyond the current fiscal year should be prorated between expense and prepaid expense over the entire period for which lease payments are waived. Leasehold improvements do not include moveable equipment or furniture because at the end of the lease OUS still retains title to the moveable equipment or furniture.

Leasehold improvement records must be removed from the accounting records at the end of the lease when the leasehold improvement reverts to the lessor.

OUS has the following reporting objectives for leasehold improvements:

  • To separately identify leasehold improvements in the Banner Fixed Assets system. Leasehold improvements are separately identified in the Banner Fixed Assets system through a “LH” user attribute defined code.
  • To record leasehold improvement in the correct real property asset category (e.g., buildings, land improvements) for financial reporting purposes.
  • To allow for different service lives for different leasehold improvements. For leasehold improvements records, the amortization life is defaulted to the asset type associated with the kind of improvement. One can change the default service life to the remaining life of the operating lease.
  • To ensure that asset records and accumulated depreciation records of leasehold improvements are removed when operating leases expire.

.210 UNIVERSITY AS LESSOR

An institution may enter into an operating lease as the lessor when leasing an asset to either an outside entity or another OUS institution. It would be unusual for an institution to be the lessor in a capital lease. If your institution is contemplating such a transaction, please contact the OUS Controller's Division.

A. OPERATING LEASE WITH ENTITY OUTSIDE OF OUS

  1. ACCOUNTING REQUIREMENTS

    2.

    No entries are made in Banner FIS at the inception of the operating lease. Accounting transactions in Banner FIS are limited to recording the periodic revenue of the operating lease. If maintenance or other costs are billed to the lessee, they should be accounted for in the proper income account codes. Institutions are required to maintain a record of all operating leases to provide information for the notes to the annual financial statements.

  2. FINANCIAL REPORTING REQUIREMENTS

    3.

    In the notes to the annual financial statements, OUS is required by GAAP to disclose operating lease receivables. To meet these reporting requirements, institutions are required to submit a schedule of future lease receivables for all non-cancelable operating leases, including current year lease rental income.

    Institutions are also required to provide certain information relating to land, property or equipment that is leased out. The information should include type of asset being leased, capitalized cost of the leased asset, accumulated depreciation on the leased asset and a description of the leasing arrangement.

    At fiscal year-end institutions are required to submit this information in two schedules to the Chancellor's Office Controller's Division: Operating Lease - Minimum Future Rentals schedule (FS.13.a) and Operating Lease Receivables - Leased Asset Information schedule (FS.13.b)

    Refer to the annual closing of the books instructions for the requested format of the reports.

B. OPERATING LEASE BETWEEN OUS INSTITUTIONS

  1. ACCOUNTING REQUIREMENTS

    2.

    No entries are made in Banner FIS at the inception of the operating lease. Accounting transactions in Banner FIS are limited to recording the periodic revenue or expense of the operating lease. Institutions are required to maintain a record of all operating leases to provide information for the notes to the annual financial statements.

  2. FINANCIAL REPORTING REQUIREMENTS

    3.

    In order for operating leases between institutions to be eliminated from the financial statements, institutions are required to submit a schedule of such leases at year-end as part of the closing of the books. Both the lessee and lessor institutions need to report the lease.

    The lessor institution needs to report the type of asset being leased, capitalized cost of the leased asset, accumulated depreciation on the leased asset, a description of the leasing arrangement, the institution the asset is leased to, and lease income for the year.

    The lessee institution needs to report a brief description of the leased asset, the institution the asset is leased from and lease expense for the year.

    Refer to the annual closing of the books instructions for the requested format of the reports.

.220 SALE AND LEASEBACK

A sale and leaseback occurs when an institution sells an asset and then enters into a lease agreement to lease the asset back. If your institution is contemplating a sale/leaseback transaction, please contact the OUS Controller's Division. The four capitalization criteria in section .200A must be applied to the leaseback in order to determine if it is a capital or operating lease.

A. ACCOUNTING FOR SALE/LEASEBACK TRANSACTION


The sale of the asset could result in a gain or loss. However, the leaseback of the same asset must be considered in the accounting of the gain or loss. The institution has the same asset and therefore, any gain or loss on the sale should be deferred.

If the leaseback is an operating lease, the deferred gain or loss should be recognized proportionally to the lease payments. If the lease is a capital lease, the deferred gain or loss should be recognized proportionally to lease depreciation.

There are two exceptions to the rule of deferring a gain or loss. The institution may record the gain or loss on the sale immediately if, in the leaseback, it retains usage of a substantially smaller portion (10% or less) of the total asset. Also, a loss is recognized immediately if the asset's fair value at the time of the sale is less than its undepreciated cost. In this case, the amount of the loss to be recognized is the difference between the undepreciated cost of the asset and its fair value.

See Appendix .700 for examples of accounting entries.

B. REPORTING REQUIREMENTS FOR SALE/LEASEBACK

INVOLVING PERSONAL PROPERTY

For sale/leaseback transactions involving only personal property, the institution should include the lease information in the appropriate schedule for either a capital or operating lease.

INVOLVING REAL PROPERTY

For sale/leaseback transactions involving real property, there are additional reporting requirements. Institutions must report to the Chancellor's Office Controller's Division, a description of terms of sale/leaseback transaction, including future commitments, obligations, and other provisions that require or result in the institution's continuing involvement. OUS must disclose in the notes to the financial statements, the obligations for future minimum lease payments.

Refer to the annual closing of the books instructions for the requested format of the reports.

.230 IRS FILING REQUIREMENTS FOR LEASE/PURCHASE AGREEMENTS

Each year, OUS is required to report to the IRS all leases entered into during the previous calendar year for which the OUS may ultimately acquire an interest in the property. This can be either through a bargain purchase option or title transfer. For IRS reporting purposes, the OUS capitalization threshold of $5,000 does not apply. Financing agreements must have a stated interest rate and the cost of purchasing the asset should be less than the estimated economic value of the asset at the termination of the lease/purchase (Bargain Purchase Option.) Individual leases of less than $100,000 can be aggregated and reported on IRS Form 8038-GC "Informational Return for Small Tax-Exempt Governmental Bond Issues and Installment Sales." The filing deadline for this form is February 15th. Individual lease purchase agreements entered into during the year that equal or exceed $100,000 must be reported separately on IRS Form 8038-G "Information Return for Tax-Exempt Governmental Obligations." The reporting deadline for this form is on or before the 15th day of the 2nd calendar month after the close of the calendar quarter in which the lease is entered into. (i.e. If a qualifying lease is entered into on July 10th, it must be reported to the IRS by November 15th.) If an institution enters into a lease/purchase agreement that meets these reporting requirements, the lease must be reported to the Chancellor's Office Controller's Division, Debt Manager within 30 days of the lease inception.

For purposes of these IRS forms, the "entered into date" for a lease or installment purchase is defined as "the date interest starts to accrue."

See Appendix .700D for specific data to be reported and requested reporting format.

.690 CONTACT INFORMATION

Direct questions about this policy to the following offices:

Subject Contact
General questions from institutional personnel Institution Office of Business Affairs
General questions from institutional central administration and Chancellor's Office personnel Chancellor's Office Controller's Division

.695 HISTORY

03/09/07 - Approved

Policy Last Updated 03/07/07 08/12/08

APPENDIX

.700 ACCOUNTING EXAMPLES

Note: It is understood that there are a number of ways to accomplish the desired end result in accounting for leases. So long as the institution's accounting records properly record lease payable liability, annual interest and executory costs at year end, each institution may set its own accounting procedures for leases.

A. CAPITAL LEASES

There are a number of steps involved in accounting for a capital lease. They include:

  • Recording the capital lease in Banner Fixed Assets.
  • Capitalizing the fixed asset.
  • Entering a JV in FIS to reclassify the equity associated with the asset to a capital lease payable liability.
  • Making periodic lease payments of principal, interest and executory costs.
  • Recording depreciation on the capitalized lease.
  • Removing accumulated depreciation and asset from the accounting records if the institution does not retain ownership of the asset at the end of the lease.

The following example illustrates the accounting entries for a capital lease:

Example of Capital Lease Accounting Entries

B. OPERATING LEASES

Accounting for an operating lease is fairly straight forward in that each lease payments is a current year expense as it occurs. If a lease contains scheduled rent increases, the institution must spread the expense evenly over the life of the lease. This may result in the institution recording a liability or a prepaid, depending on the situation. The following example illustrates the accounting entries for an operating lease:

Example of Operating Lease Accounting Entries

C. SALE/LEASEBACK

There are a number of steps involved in accounting for a sale/leaseback. They include:

  • Disposing of the fixed asset.
  • Recording deferred gain or loss on sale unless either of the two exceptions in .220A is met.
  • Determining if the leaseback is a capital or operating lease and recording it appropriately.

The following example illustrates the accounting entries for a sale/leaseback:

Example of Sale and Leaseback Accounting Entries

D. IRS LEASE/PURCHASE REPORTING

For purposes of reporting lease/purchase agreements to the IRS, please provide the following information to the Chancellor's Office Controller's Division, Debt Manager:

  • Lessor's Name
  • Type of property being leased
  • Lease Inception Date
  • Lease Issue Price (principal amount of property being leased)

The following is an example of the data to be submitted:

Appendix Last Updated: 03/07/07
 

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