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**SFFAS 54 LEASE GUIDANCE:**

**SHORT-TERM LEASES**

**RENEWAL OPTIONS**

**LEASE CONCESSIONS**

**EFFECTIVE FISCAL YEAR 2024**

**PREPARED BY:**

**GENERAL LEDGER AND ADVISORY BRANCH**

**BUREAU OF THE FISCAL SERVICE**

**U.S. DEPARTMENT OF THE TREASURY**

**SHORT-TERM LEASE WITH RENEWAL OPTIONS**

**Effective Fiscal 2024**

Page 40 of 41                                                                                  November 2022

**Proprietary Accounting Requirements & Agency Decision Points**

SFFAS No. 54, *Leases*, as amended by SFFAS No. 60, *Omnibus Leases-Related Topics*, replaces proprietary lease accounting and disclosure standards for general purpose federal financial reports. SFFAS No. 54 is effective for reporting periods beginning after September 30, 2023. (Early implementation is not permitted.)

A lease is defined as “a contract or agreement whereby one entity (lessor) conveys the right to control the use of PP&E (the underlying asset) to another entity (lessee) for a period of time as specified in the contract or agreement in exchange for consideration.” (SFFAS 54, Par. 6)

**Short-Term Leases**

Short-Term leases are non-intragovernmental leases with a lease term of 24 months or less. Short-term lease payments are recognized as expenses/revenues based on the payment provisions of the contract and the respective payables/receivables standards. Reporting entities do not record lease liabilities or lease assets for short-term leases.  (SFFAS 54, Pars. 23-24)

For proprietary accounting, entity management is responsible for exercising professional judgement and collaborating within its agency to reach certain determinations before establishing proprietary accounting treatment, including:

**1)** Lease Term, with consideration for Options, Renewals/Terminations, and Cancellation Clauses; 

**3)** Interest Rates - Amortization of Discount on Lease Liability/Receivable; and

**4)**Modifications, Terminations, and any respective remeasurements.

**Proprietary Lease Term**

For proprietary accounting, calculating the lease term is pivotal because the classification between short-term leases and right-to-use leases depends on the lease duration. The lease term is determined to be the noncancelable lease period, plus certain periods subject to options to extend or terminate the lease. The noncancelable period is the shorter of the period agreed upon in the lease contract that: **(1)** precedes any option to extend the lease; or **(2)** precedes the first option to terminate the lease.  In addition, the lessee’s lease term should include the noncancelable period, along with periods:

· Involving an option to extend the lease, if it is probable that the lessee or lessor will exercise that option (SFFAS 54, Par. 15a & 15c)

· Following an option to terminate the lease, if it is probable that the lessee or lessor will not exercise that option (SFFAS 54, Par. 15b & 15d)

Some specific provisions may also need to be applied when determining the lease term:

· Periods for which the lessee/lessor **(1)** have an option to terminate the lease without permission from the other entity, or **(2)** have to agree to extend, are considered to be cancelable periods and are thus excluded from the lease term (SFFAS 54, Par. 19a.)

· An availability of funds/cancellation clause allowing lessees to cancel a lease agreement if funds for the lease payments are not appropriated should only affect the lease term when it is probable that the clause will be exercised (SFFAS 54, Par. 19c.)

· If a lessee has the option to purchase the underlying asset during the lease term and the contract is not a contract that transfers ownership, the lease term should exclude the period, after the date at which the option is probable of being exercised (SFFAS 61, Par. 19d.)

**Lease Concessions**

On certain occasions, Lessors will offer rent discounts in order to persuade a potential Lessee to sign a lease contract.  SFFAS 60 amends SFFAS 54 guidance, stating that these lease concessions are to be recognized by the lessee as reductions of lease rental expense when incurred.  Likewise, lease concessions should be recognized by the lessor as reductions in rental income as incurred. (SFFAS 60, Par. 15 rescinds SFFAS 54, Pars. 32-33.)  FASAB Technical Release 20, Par. 36, provides one example of how concessions should be recognized.

**Advances/Prepayments**

If the lease contract allows for prepayments or advance payments, a Lessee should recognize a prepaid asset if payments are made in advance of the reporting period to which they relate, as well as a payable for rent due and unpaid at the end of the reporting period to which they relate.  Likewise, a Lessor should recognize a liability for advances and prepayments if payments are received in advance of the reporting period, or a receivable for rent due and to be received. (SFFAS 54, Pars. 23-24, *as amended by* SFFAS 60, Pars. 9-10)

**Budgetary Accounting Requirements & Agency Decision Points**

While proprietary accounting requirements for leases are transformed by SFFAS 54, *Leases*, budgetary accounting requirements will remain unchanged and continue to be guided by the lease scorekeeping rule developed by OMB, CBO, and the House and Senate Budget Committees originally in connection with the Budget Enforcement Act of 1990, and guidance regarding this rule provided in*OMB Circular No. A-11, Appendix B, Budgetary Treatment Of Lease-Purchases and Leases of Capital Assets.*

For budgetary accounting, entity management is responsible for exercising professional judgement and collaborating within its agency to reach certain determinations before establishing budgetary accounting treatment, including:

**1)** Operating vs. Capital Lease (as defined by Appendix B of OMB Circular No. A-11); 

**2)** Budgetary Lease Term, with consideration for Cancellation Clauses; and

**3)** Budget Authority and Outlays.

**Operating/Capital/Lease-Purchase**

The lease scorekeeping rule developed by OMB, CBO, and the House and Senate Budget Committees originally in connection with the Budget Enforcement Act of 1990, and related guidance in*OMB Circular No. A-11, Appendix B* does not classify leases into the same buckets as FASAB’s SFFAS No. 54.  Rather than intragovernmental, short-term, or right-to-use classifications, the lease scorekeeping rule distinguishes leases as either “Operating”, “Capital”, or “Lease-Purchases.”

“An Operating Lease meets all the criteria listed below. If the criteria are not met, the lease will be considered to be a capital lease or a lease-purchase:

•	Ownership of the asset remains with the lessor during the term of the lease and is not transferred to the Government at or shortly after the end of the lease term;

•	The lease does not contain a bargain-price purchase option;

•	The lease term does not exceed 75 percent of the estimated economic life of the asset;

•	The present value of the minimum contractually required payments over the life of the lease does not exceed 90 percent of the fair market value of the asset at the beginning of the lease term;

•	The asset is a general purpose asset rather than being for a special purpose of the Government and is not built to the unique specification of the Government as lessee; and

•	There is a private sector market for the asset.”

Operating leases allow agencies to budget their lease costs annually, while capital leases require the agency to budget the entire asset cost (net present value of all lease and other contractually required payments over the lease term) up-front, including any option/renewal terms.  

Reporting entities should apply professional judgment, consistent with the guidance in *Appendix B* of *OMB Circular No. A-11*, on Operating Leases/Capital Leases criteria to discern the correct budgetary treatment of leases deemed to be Short-Term for proprietary accounting.  This may or may not include consultation with OMB, depending on the specific characteristics of the transaction.

**Budgetary Lease Term & Renewal Options**

One step in determining the proper budgetary treatment is calculating the term of the lease.  *OMB Circular No. A-11*, *Appendix B* states agencies should presume that all options will be exercised when calculating the lease term:

“If the lease agreement contains an option to renew that can be exercised without additional legislation, it will be presumed that the option will be exercised.  If the lease agreement contains an option to purchase at less than fair market value (at the time the option is to be exercised), and the option can be exercised without additional legislation, it will be presumed that the option will be exercised.”

This calculation then factors into the six-part operating lease/capital lease test, excerpted above.

**Budget Authority and Outlays – Operating Lease**

Assuming all six parts of the operating lease test above are met, this would mean the lease should be considered an operating lease for budgetary purposes.  The lease scorekeeping rule prescribes the following budgetary treatment for budget authority and outlays:

“For operating leases, budget authority is required to be obligated up front in the amount necessary to cover the Government's legal obligations, consistent with the requirements of the Antideficiency Act. This will include the estimated total payments expected to arise under the full term of the contract or, if the contract includes a cancellation clause, an amount sufficient to cover the lease and other contractually required payments for the first year plus an amount sufficient to cover the costs associated with cancellation of the contract. For each subsequent year, sufficient budget authority is required to be obligated to cover the annual lease payment for that year plus any additional cancellation costs.”

The amount necessary to cover the Government’s legal obligations in the example below is the first noncancelable period’s total amount of lease payments.   The Government does not incur an obligation for the second year until it exercises the renewal option.

Some agencies may have special legislative authority to enter into long-term leases, and only funding for the first year must be available to obligate. Obligations are recorded each year as they become due.  However, these agencies are still required to evaluate proposed lease transactions against the six-part operating lease test as well as follow other guidance included in Appendix B of OMB Circular No. A-11.

**Budget Authority and Outlays – Capital Lease**

At other times, short-term leases could be considered ‘Capital leases’ for budgetary purposes when one of the criteria above is not met.  In these cases, the lease scorekeeping rule prescribes the following budgetary treatment:

“The up-front budget authority required for capital leases (called the asset cost) is the present value of the minimum lease and other contractually required payments excluding payments for identifiable annual operating expenses that would be paid by the Government as owner, such as utilities, minor maintenance, and insurance. Property taxes will not be considered to be an operating expense and will be included in the calculation of the up-front budget authority. Other contractually required payments include any and all costs related to the asset being leased in addition to the rent fee applied under the lease.”

If management determines the lease to be a “Capital lease” for budgetary treatment, it should calculate the asset cost (present value of the minimum lease and other contractually required payments.) As part of this calculation, the agency would be required to assume the renewal option is exercised.  The agency would then obligate the asset cost (present value of the full 24 months of payments) upfront upon signing the lease.

**Key Assumptions Driving Proprietary Accounting Entries:**

**Lease Term & Classification**

· A federal reporting entity (Lessee) signs a 12-month lease with a non-federal Lessor for use of equipment, in which the monthly lease payments are $100,000.  In the corresponding example titled “Lessor Entries”, a federal reporting entity acts as a Lessor conducting business with a non-federal lessee.  (i.e., transactions are not taking place between both entities within the examples.)

· In addition to the initial 12-month period, the lease contract specifies that the Lessee has an option to extend the lease by another 12 months.  Management believes it is probable, based on all relevant factors, that it will exercise that option.  Therefore, the lessee’s lease term is 24 months, which includes the noncancelable period of the initial 12 months, plus the following 12-month renewal period (See SFFAS 54, Pars. 14-15a.)  Thus, management determines the lease term to be 24 months, meeting the definition of a Short-Term Lease per SFFAS 54.

· The Lessor already has equipment on its Balance Sheet with a cost basis of $1,000,000 prior to the start of the lease contract and $850,000 Accumulated Depreciation.  The equipment has a 20-year useful life and depreciation expense is $50,000 annually.

· The lease contract within this scenario does not allow for prepayments or advance payments.

**Lease Concessions**

· As part of a lease concession, the Lessor will give $20,000 in reduced rent as the Lessee meets all occupation contingencies in the contract.  The Lessee qualifies for reduced rent in each of the first three months of the lease term.

· The $20,000 reduced rent is awarded after the Lessee meets the contract contingencies only in months 1-3. Thus, the Lessee recognizes the reduction in rental expense **as incurred** in each of the first 3 months by recording $20,000 less in rental expense in months 1-3.

· In months 4-12, the Lessee recognizes the full $100,000 monthly rent payment. (See Also FASAB Technical Release 20, *Lease Implementation Guidance*, Par. 36.)  The lease concessions are recognized as incurred and not spread out across the entire lease term.

**Key Assumptions Driving Budgetary Accounting Entries:**

**Budgetary Authority**

· The Lessee received a direct appropriation and is working from an annual TAFS from a general fund expenditure account.  Agency management has concluded that appropriations language allows the budget authority to remain available for the lease and other contractually required payments over the full term of the lease.

**Budgetary Lease Capital/Operating Determination**

· Appendix B states that agencies should presume that all options will be exercised when calculating the lease term, if it can be exercised without additional legislation.  Therefore, the lease term for purposes of distinguishing between capital and operating leases is 24 months: the initial 12-month period plus the 12-month renewal option.

· Management concludes that the lease satisfies the six-part test to be considered an “**Operating lease**” for budgetary purposes.

· As an ‘Operating’ lease for budgetary treatment, budget authority is obligated up front in the amount necessary to cover the Government's legal obligations, which in this case includes the estimated total payments expected to arise under the full term as there is no cancellation clause.

· The amount necessary to cover the Government’s legal obligations is only the first 12 months of lease payments; the agency does not incur an obligation for the second year until it exercises the renewal option.

· Because the lease concession is not fixed as part of the initial contract, the agency’s obligation should include the full amount of the first three months’ lease payments.

**Budgetary Outlays**

· Since the lease is an “Operating lease” for budgetary purposes, Outlays will be scored over the lease term, equal to the annual lease and other “contractually required payments.” Agency management has determined all outlays are in fact contractually required payments.

**Listing of USSGL Accounts Used in This Scenario:**

**Disclaimer**

The below guidance is intended to serve as a reference only based on a finite number of underlying assumptions.  It is in no way intended to provide comprehensive posting logic for every leasing activity.  Agencies should have a thorough understanding of authoritative standards SFFAS 54, SFFAS 60, and SFFAS 61, and apply other factors, including but not limited to certain prepayments, accruals, etc.  As stated above, agency management must exercise professional judgement and collaborate within their agency to reach determinations of lease activities on a lease-by-lease basis, before establishing accounting treatment.  

Budgetary and/or legal staff should ascertain the applicability of certain budgetary accounting terms from OMB Circular No. A-11, Appendix B, including but not limited to “contractually required payments.”

Entity management should document these decisions and incorporate them into management’s existing OMB Circular No. A-123, “Management's Responsibility for Enterprise Risk Management and Internal Control,” Appendix A, procedures.

**Short-Term Leases with Rent Concessions**

**Lessee Accounting**

**Lessor Accounting**

**Pre-Closing Adjusted Trial Balance:**

**Lessee Closing Entries:**

**Lessor Closing Entries:**

**Post-Closing Adjusted Trial Balance:**

**Financial Statements:**

**Reclassified Financial Statements:**

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