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05.22.19

Three Landlord-Friendly Fixes to Lease Accounting Rules
Michael Kovacs

The new rules on accounting for leases have already taken effect for public companies and will apply to all other entities in 2020. While most of the rule changes apply to tenants, some of the provisions mark a departure for landlords — and many parties raised concerns about the rules’ cost and complexity soon after their release.

The Financial Accounting Standards Board (FASB), the body behind the lease accounting standard, responded by making some “narrow-scope amendments” intended to facilitate implementation for landlords. The amendments address three areas.

  1. Sales and Similar Taxes Collected from Tenants
    The new lease standard requires landlords to determine, on a jurisdiction-by-jurisdiction basis, whether sales taxes and similar taxes are the primary obligation of the landlord or are collected by the landlord on behalf of others. If they are the landlord’s primary obligation, the landlord would include that amount in lease revenue and costs. However, if they are collected on others’ behalf, the landlord would exclude the amount from lease revenue. The FASB amendments allow landlords to elect not to evaluate whether these taxes are costs of the landlord or the tenant. The landlord instead can account for them as costs of the tenant, excluding them from lease revenue and the associated expense.
  2. Certain Landlord Costs Paid Directly by Tenants
    The lease standard also requires landlords to recognize as revenue and expenses any costs paid directly by tenants on the landlord’s behalf or as a reimbursement to the landlord. This, in turn, often would require a landlord to estimate the amounts paid directly by a lessee on its behalf. The amendments require landlords to exclude certain costs paid directly by tenants to third parties on landlords’ behalf from variable payments — and therefore from revenue. The amendments also require landlords to account for costs excluded from the consideration of a contract that are paid by the landlord and reimbursed by the tenant as variable payments. A landlord will record those reimbursed costs as revenue.
  3. Variable Payments for Contracts with Lease and Nonlease Components
    A lease agreement may include lease and nonlease components (for example, common area maintenance charges). Under the lease standard, landlords must recognize certain variable payments in profit or loss in the period when there are changes in facts and circumstances on which the payments are based occur (such as a change in the rentable space) — regardless of whether a payment partly relates to nonlease components. The amendments clarify that landlords should allocate (rather than recognize) these payments to the lease and nonlease components when the changes occur. After the allocation, the lease component is recognized in profit or loss according to the lease standard. Landlords will need to recognize the nonlease components according to the applicable accounting rules, such as the revenue recognition standard for contracts with customers.

Effective Dates

The landlord-friendly amendments have the same effective dates as the new lease accounting standard. For public companies, they took effect for annual periods beginning after December 15, 2018, and interim periods within those years. For all other entities, the lease accounting standard and amendments take effect for annual periods after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.   Remember, these are GAAP accounting changes and do not affect income tax accounting for leases.

For more information, contact Mike Kovacs at mkovacs@orba.com or 312.670.7444. Visit orba.com to learn more about our Real Estate Group.

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