Leases can be complex documents that become increasingly complicated when facing changing lease accounting standards and requirements. To make it even more confusing, both lease and non-lease components may be incorporated into the same document. However, compliance with GASB 87 lease accounting standards means that these various components need to be identified and accounted for differently.
In 2017, the Governmental Accounting Standards Board (GASB) issued Statement No. 87. Its objective is to better meet the information needs of financial statement users by improving accounting and financial reporting for leases by governments.
Per GASB 87:
Generally, a government should account for the lease and non-lease components of a lease as separate contracts. If a lease involves multiple underlying assets, lessees and lessors in certain cases should account for each underlying asset as a separate lease contract. To allocate the contract price to different components, lessees and lessors should use contract prices for individual components as long as they do not appear to be unreasonable based on professional judgment, or use professional judgment to determine their best estimate if there are no stated prices or if stated prices appear to be unreasonable.”
So, what does this mean for you?
A lease contract can involve lease components, non-lease components, and items that are not considered a contract component. Lease components provide the right to use an underlying asset and involve the transfer of a good or service. Examples of lease components include the intangible rights to the underlying asset, such as the right to use a building or sometimes an adjacent plot of land. Non-lease components are elements of a contract that are not related to the use of a leased asset; they are commonly found in real estate leases. Examples of non-lease components include services contracts for the leased asset and common area maintenance (CAM). You may also have items that are not considered a contract component, which may include insurance and real estate taxes, which are paid for separately from the regular rent payment. During implementation of GASB 87, certain criteria must be applied to determine whether the lease contract includes a lease component and then one or more non-lease components that must be accounted for separately.
Most municipalities have one or more type of commercial real estate leases, such as for government office space, police headquarters, or parking decks. The lease structure determines what components are included in rent payments or which may be additional. John Christenbury, Tenant Representative at CBRE, describes these lease structures as a spectrum with regards to breaking out specific components as separately billed payments. Common lease structures include:
Claire Devon, Office Tenant Representative at Foundry Commercial, expanded on the above, noting that when determining whether or not CAM charges are included in the new leasing standard requirement and how to record the right of use asset (ROU) and related lease obligation, it will depend on if the tenant elects to accept the “practical expedient” method or not. In doing so, the tenant combines CAM with the lease payment in booking the ROU and obligation. In essence, if CAM is a fixed amount and does not change, then it is included in the calculation; if it’s simply a shared portion of total expenses, then it is excluded.
Devon also notes another way tenants save money is by limiting what expenses can be passed off by the Landlord as operating expenses. Capital improvements that are not required by law, aesthetic in nature, and do not improve the operational efficiency of the building should not be included in a building’s operating expenses. Devon also recommends negotiating a cap on annual increases in operating expenses to further protect tenant’s from unforeseen costs.
Properly negotiated lease contracts will also include the ‘right to audit’, in which tenants can request the landlord for operating expenses over the prior year. If the landlord has been underestimating operating expenses, the tenant can receive a reconciliation bill. Christenbury says that tenants should take advantage of the right to audit operating expenses, as there can often be missed savings when landlords overcharge.
There are two primary methodologies for allocating the contract prices to the different types of components:
There is one caveat with using comparable market goods and services when it comes to real estate. Per Devon, the values of two identical buildings in different locations will not be the same -- the real estate itself is what is driving the value.
GASB 87 does not offer a list of lease and non-lease components. For every lease, organizations need to perform the following:
Lease management software, such as DebtBook, can help organizations implement GASB 87 and maintain ongoing compliance. With quick set-up and intuitive workflows, implementation is straight-forward and painless. Want to learn more? Ready to get started? Click HERE!
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