Administrative Procedure

Leases

1. Purpose

This procedure provides general guidance on lessee accounting for leases.

This procedure is not comprehensive. It does not include guidance related to certain transactions which are addressed in GASB 87 that KCTCS typically does not engage in, such as, lessor accounting, lease modifications, lease terminations, subleases, lease-leasebacks or sale-leasebacks. Please contact KCTCS General Accounting for requirements in the event that you engage in these types of transactions

2. Scope

This procedure applies to all colleges and the System Office.

3. General

A lease is an agreement or contract that conveys control of the right to use another entity’s nonfinancial asset (e.g., buildings, land, vehicles, and equipment). A lease is entered into for a certain period of time (lease term) as stated in the agreement or contract. A lease is negotiated in an exchange or exchange-like transaction. Please contact KCTCS General Accounting with questions.

4. Lease Term

The lease term is the “noncancelable period” during which the lessee has a right to use the leased asset. The “noncancelable period” is the period in which the lessee and the lessor are legally obligated without the possibility of cancellation (i.e., neither party can cancel).

The lease term also includes the following periods, if applicable:

1. Periods during which the lessee has the option to extend the lease if it is “reasonably certain” that the lessee will exercise the option.
2. Periods during which the lessee has the option to terminate the lease if it is “reasonably certain” that the lessee will NOT exercise the option.
3. Periods during which the lessor has the option to extend the lease if it is “reasonably certain” that the lessor will exercise the option.
4. Periods during which the lessor has the option to terminate the lease if it is “reasonably certain” that the lessor will NOT exercise the option.

“Reasonably certain” means that it is very likely to occur.

The lease term DOES NOT INCLUDE periods in which BOTH the lessee AND the lessor have the right to terminate without permission from the other party or where both parties have to agree to extend.

A lease may contain a “fiscal funding/cancellation” clause. Such a clause allows KCTCS to cancel a lease if the Commonwealth of Kentucky does not appropriate funds for the lease payments. “Fiscal funding/cancellation” clauses should only be factored into the calculation of the lease term if it is reasonably certain that the clause will be exercised.

5. Lease Types

There are three (3) types of leases: short-term, financed purchase, and capital. 

1. Short-term lease
   1. A short-term lease has a “maximum possible term” of 12-months or less.
      1. Options to extend are included in the “maximum possible term” regardless of probability of exercising the option.
         • Except that, if a lease is cancelable by BOTH parties, then the “maximum possible term” is the non-cancelable period (the period in which BOTH parties may NOT cancel – sometimes this may simply be the notice period) – in this case, options to extend are disregarded.
         • If a lease is cancelable by ONLY ONE of the parties, the “maximum possible term” is the “non-cancelable period” (the period in which BOTH parties may NOT cancel) plus any options to extend regardless of probability.
      2. If the result of this calculation exceeds 12-months, then the lease is considered either a financed purchase or a capital lease and the lease term (for purposes of calculating the amounts to record) is calculated in accordance with the rules stated in Section 4, Lease Terms.
   2. A short-term lease is recorded as rent expense, as incurred, with a corresponding credit to cash or accounts payable.
   3. A capital asset is not recorded for a short-term lease, therefore, there is no depreciation for a short-term lease.
   4. A liability is not recorded for a short-term lease, therefore, there is no interest expense for a short-term lease.
      
      
2. Financed purchase
   1. A financed purchase transfers ownership of an asset by the end of the contract but not under a purchase option.
   2. A financed purchase does not contain a termination option but may contain a fiscal funding or cancellation clause that is not reasonably certain of being exercised.
   3. A payment on a financed purchase is recorded as an outflow of cash and a reduction of liability for the principal portion and interest expense for the interest portion. Interest expense is accrued as incurred.
   4. A capital asset is recorded for a financed purchase.
   5. A liability is recorded for a financed purchase.
   6. Depreciation is recorded for the capital asset (unless it is a non-depreciable asset, such as land).
      
      
3. Capital lease
   1. A capital lease is a lease which does not meet the definition of a short-term lease or of a financed purchase.
   2. KCTCS has established a threshold of $5,000 for recording capital leases.
      1. Leases which are $5,000 and less will be classified as short-term unless they meet the criteria for a financed purchase.
   3. A payment on a capital lease is recorded as an outflow of cash and a reduction of liability for the principal portion and interest expense for the interest portion. Interest expense is accrued as incurred.
   4. A right-to-use asset is recorded for a capital lease.
      1. Amortization is recorded for the right-to-use asset.
   5. A liability is recorded for a capital lease.
   6. Amortization is recorded over the shorter of the lease term or the useful life of the leased asset (see also 6C, below).

6. Measurement: Capital Lease Liability and Right-to-Use Asset

1. Liability
   1. The capital lease liability is calculated as the present value (PV) of the expected payments to be made during the lease term including but not limited to (see GASB 87, paragraph 21):
      1. Fixed payments
      2. Variable payments that are fixed in substance or that depend on an index or rate
      3. Other payments that are reasonably certain of being required
      4. Lease incentives to be received by the lessee will be included as a reduction to the PV calculation.
      5. Variable payments based on future performance (or usage) should not be included in the measurement of the lease liability. Such payments should be expensed. However, any component of variable payments that is fixed in substance should be included in the measurement of the lease liability.
         
         
2. Right-to-Use Asset
   1. The right-to-use asset is calculated as:
      1. The initial amount of the capital lease liability (as calculated, above).
      2. Plus: Lease payments made by the lessee at or before the commencement of the lease term.
      3. Minus: Lease incentives received by the lessee at or before the commencement of the lease term.
      4. Plus: Initial direct costs that are ancillary charges necessary to place the leased asset in service.
         • Except for debt issuance costs (see GASB 87, paragraph 30).
           
           
3. Amortization Period 
   1. A lease asset should be amortized over the shorter of the lease term or the useful life of the underlying asset, except as discussed, below.
   2. If a lease contains a purchase option that the lessee has determined is reasonably certain of being exercised, the lease asset should be amortized over the useful life of the underlying asset. In this circumstance,if the underlying asset is nondepreciable, such as land, the lease asset should not be amortized.

7. Contracts with Multiple Components

1. Contracts / agreements may cover multiple components such as multiple types of agreements (lease and non-lease) or multiple assets.
   1. Lease and non-lease components should be accounted for separately unless:
      1. The contract does not include prices for each type of component and it is not reasonably possible to determine an estimate of the value to assign to each component, or
      2. The prices for separate components appear unreasonable and it is not reasonably possible to determine an estimate of the value to assign to each component
      3. Example: A lease agreement which meets the requirements for a capital lease may contain the right to use a facility as well as an agreement to pay janitorial services for the facility. The facility should be accounted for as a capital lease and the janitorial services should be expensed as incurred unless one of the exceptions in item a or b, above, applies.
         
         
2. The following departments will notify Accounting of each contract / agreement entered into which has a total contract price that exceeds $5,000 and which contains lease and non-lease components and/or an embedded lease:
   1. Asset Management
   2. Budgeting
   3. Procurement
   4. Technology Solutions
   5. General Counsel (with regard to with regard to Memoranda of Agreement or Understanding)

The Director of Accounting will review agreements containing multiple types of agreements to ensure compliance with GASB 87.

Contracts / agreements reviewed and conclusion regarding GASB 87 requirements will be documented in a shared file maintained at:  \KCTCS\SO General Accounting - Accounting Documents\Audit Files\Audit\GASB87 Contracts.xlsx.

Note: Accounting will update the above spreadsheet for contracts/agreements discussed with Asset Management and General Counsel. Budgeting, Procurement and Technology Solutions will update the spreadsheet for contracts/agreements from their respective areas. Instructions are provided in the spreadsheet.

8. Contract Combination

1. Contracts/agreements that are entered into at or near the same time with the same counterparty should be considered part of the same contract if either of the following criteria is met:
   1. The contracts are negotiated as a package with a single objective or
   2. The amount of the consideration to be paid in one contract depends on the price or performance of the other contract.
      
      
2. If multiple contracts / agreements are determined to be part of the same contract, that contract should be evaluated in accordance with the guidance for contracts with multiple components (Section 7, above).