REAL ESTATE LEASE ACCOUNTING

REAL ESTATE LEASE ACCOUNTING WHAT CHANGES UNDER ASC 842 2017 LeaseAccelerator Inc. Page 1

REAL ESTATE LEASE ACCOUNTING KEY POLICY ELECTIONS MARK KOPPERSMITH & SCOTT SILVER Defining Asset Classes Asset versus Contract Level Separating Lease and NonLease Components www.leaseaccelerator.com 2

Defining Asset Classes OFFICE BUILDINGS DISTRIBUTION CENTERS MANUFACTURING PLANTS Page 3

Asset vs. Contract-Level Accounting Examples of Potential Assets on a Real Estate Lease Floors Storage Space Parking Signage Land Why Asset-Level Lease Accounting is Critical for Real Estate Recording leases at the asset-level: Makes it easier to adjust accounting if one asset is removed Limits need for manual intervention to adjust for asset-level changes Reduces risk of error Page 4

Is it a Separate Lease Component? The right to use each asset is considered a separate lease component if both of the following criteria are met: The lessee can benefit from the right of use either on its own or together with other resources that are readily available The right of use is neither highly dependent on, nor highly interrelated with, the other right(s) to use underlying assets in the contract What About Land? Page 5

Polling Question #1 Do you plan to establish more than one category of real estate assets? a) Yes b) No c) Undecided Page 6

REAL ESTATE LEASE ACCOUNTING LEASE & NON-LEASE COMPONENTS MARK KOPPERSMITH & SCOTT SILVER Components of a Real Estate Lease Defining Lease and Non-Lease Standalone Observable Price www.leaseaccelerator.com 7

Definitions: Lease and Non-Lease Lease Component Non-Lease Component Non- Component The lease component is the portion of the payment designated for transferring the right to use the asset from the landlord to the tenant The non-lease component is the portion of the payment that transfers a good or a service from the landlord to the tenant Payments that are not for the transfer of a good or service from the landlord to the tenant are not considered a component of the lease Page 8

Potential Elements of a Real Estate Lease Rent OpEx Taxes Insurance Sundry Charges Page 9

Common Real Estate Lease Arrangements Gross Modified Gross Triple Net Bundled Charges Rent Operating Expenses Taxes Insurance Bundled Charges Rent Operating Expenses Taxes Insurance Rent Operating Expenses Taxes True-Up Charges Insurance Sundry Charges Sundry Charges Sundry Charges Page 10

Separating Lease & Non-Lease Components Pros and Cons of Not Separating Pros Avoiding Administrative Complexities No need to allocate components No need to track Standalone Observable Price Cons Greater Impact to the Balance Sheet Potentially triggering a different classification Adding excess asset value to the balance sheet for goods and services Page 11

Taxes & Insurance Non-Components are generally not allocated to the lease or non-lease component Gross Lease Net Lease Taxes & Insurance are already included in the bundled charge, so they are not separated out Taxes & Insurance are presented separately, so they are accounted for separately Page 12

Standalone Observable Price Definition The standalone observable price is basically the fair market value of each component Why It s Used How It s Used Challenges Challenge It s used to ensure the allocation of the components accurately reflects how the components would be valued in the market The standalone observable price for each component will need to be tracked along with the actual invoiced payment Page 13

Sample Calculation for a Gross Lease Contractual Obligations Standalone Observable Price Allocation Payment for Asset $2000.00 $2300.00 $2053.57 Taxes & Insurance $300.00 $275.00 $245.54 CAMS $200.00 $225.00 $200.89 Total $2500.00 $2800.00 $2500.00 Lease Component Non-Lease Component ($2300 + $275) $2800 * $2500 = $2299 ($225) $2800 * $2500 = $201 Page 14

Documentation & System Challenges A lease system should track Standalone Observable Price The lease system should have the ability to track the standalone observable price This will be used by Accounting to correctly value the right-of-use asset and lease liabilities Invoiced Line Items The actual invoiced line items will be important from an operational and negotiation perspective Corporate Real Estate and Accounts Payable will use this to monitor payment changes and update accordingly. Page 15

Polling Question #2 Do you plan to separate lease and non-lease components for real estate? a) Yes b) No c) Undecided Page 16

REAL ESTATE LEASE ACCOUNTING CHANGES, MODIFICATIONS, & REASSESSMENTS MARK KOPPERSMITH & SCOTT SILVER Reassessment vs Modification Payment Adjustments, Triggering Events, and Facts and Circumstances System Considerations www.leaseaccelerator.com 17

Reassessment, Modification, & Remeasurement If there is a change to a a lease that may affect the valuation of the right-of-use asset and lease liability, it could cause a reassessment or modification. Reassessment Remeasurement Modification Results from a situation that may change the lease term or reasonably certain end-of-term option within the bounds of a contract Results from situations that would change the lease payments, although there are exceptions that differ from IFRS to US GAAP Results from a change to the terms of the contract that alters the scope, including changes to lease term or right to use the assets Page 18

Reassessments: Three Causes There are three broad categories of reassessment causing events. Some of these events may also lead to a re-measurement if the reassessment does result in a change in lease term. Triggering Events Option Obligation Change in Reasonably Certain Option Triggering Events A situation within the tenant s control that may alter reasonably certain end-of-term option Option Obligation An event in the contract obligating the tenant to elect an option that could change lease term The tenant may choose to take an option they previously chose not to, or vice versa Change in Term Change in Term Change in Term Page 19

Triggering Events Examples 1 2 Leasehold Improvements Change in Future Plans If a tenant chooses to make improvements to a space part-way through the lease perhaps to accommodate employee growth in an office space, a greater number of customers in a retail site, or a new production strategy in a factory. A significant investment could cause the tenant to want to renew their lease. Consider a situation where a tenant had planned to stay in a location long-term, but then was acquired and the acquirer wanted to move all employees to a central office. The tenant might choose an early termination option or decide to not take a renewal option they had previously planned on taking. 3 Sublease Extension Consider a situation where a tenant takes on a subtenant. The subtenant may want to remain in the location past when the tenant s term ends. If the sublease is beneficial to the tenant, they may choose to take a renewal option that they had not previously anticipated taking in order to continue the sublease. Page 20

Modifications: Out of Scope Changes A modification will occur when there is a change in the lease term or the right to use the underlying assets on lease that was out of scope of the initial contract. Depending on whether the modification results in a change to right-of-use, it may result in a new contract. Change in Right-of-Use CREATE NEW CONTRACT Example: Mid-way through the lease, the tenant negotiates an expansion to add additional square footage. This provides the tenant with additional right of use. No Change in Right-of-Use MODIFY ORIGINAL CONTRACT Example: Mid-way through the Example: lease, Mid-way the tenant through negotiates the lease, to the tenant add negotiates additional a square renewal footage. option. This is out This of scope provides of the the original tenant contract, with but does not additional change the right tenant s of use. right-of-use. Page 21

Remeasurement of Lease Payments Lease payments must be re-measured after certain events that could alter what was initially reported. Reassessment of Term Modification to Original Contract When there is a change in term or reasonably certain EOT option When it does not result in a new contract being created Resolution of Contingency Where an unknown, variable payment becomes fixed. Change in Residual Value Guarantee Estimated Payment Where the estimate of the payment that Lessee is required to make so that the value of assets returned to the Lessor meets the Guarantee (Asset Market Value + Cash) Page 22

Polling Question #3 Which modifications and reassessment scenarios do you think will be common in your business? (Check all that apply) a) Leasehold Improvements b) Changes to Future Plans c) Sublease Extensions d) New Contracts e) Modifications to Existing Contracts Page 23

Index Rent Changes: IFRS vs GAAP The IASB and FASB disagreed on how to handle payment changes based on an index, such as LIBOR or CPI ASC 842 A payment change based on an index does NOT require a remeasurement IFRS 16 A payment change based on an index requires a remeasurement Page 24

System Considerations To monitor all events that could cause a Reassessment, Modification, or Remeasurement, a lease system should be able to hold the following: Field Business Context of Payment Change Reasonably Certain End-of-Term Option Why it s Needed To know whether a remeasurement will result. A payment change based on resolution of contingency will result in a remeasurement, but a one-time payment change will not. To calculate lease term, which affects valuation of the right-of-use asset and liability. If the choice changes, the system will also need to record that change as it may trigger a reassessment. Triggering Events To record any events that could be considered triggering events so that Accounting can determine if it calls for a reassessment. Page 25

Polling Question #4 What type of real estate system do you have? a) Integrated Workplace Management System b) Real Estate Lease Administration System c) System from Outsourced Real Estate Management Firm d) No System Page 26

REAL ESTATE LEASE ACCOUNTING OPERATIONAL CONSIDERATIONS MARK KOPPERSMITH & SCOTT SILVER One System or Two Integrating Systems Corporate Real Estate & Accounting Coalition www.leaseaccelerator.com 27

Corporate Real Estate & Accounting Teams Role of Corporate Real Estate Working In Partnership Role of Accounting Managing properties and facilities based on company need Selecting optimal endof-term option on-time Monitoring payment changes Completing chargebacks Define Policies to: Keep standalone observable price up-to-date Communicate changes in endof-term choice and other events Record business context of payment change Leverage cost center allocation for operational chargebacks Selecting practical expedients and defining asset classes Reassessing based on change in term / EOT option Remeasuring based on payment change Allocating to cost centers for management reporting and budgeting Page 28

One System or Two? LEASE ADMINISTRATION Real Estate LEASE ACCOUNTING Real Estate ERP APPLICATIONS General Ledger Accounts Payable Equipment Equipment General Ledger Accounts Payable Page 29

Best of Breed Approach for Real Estate New Lease Signed Change To Rent Schedule Increase Or Decrease Floor Space New Sub Tenant Change To End Of Lease Plans Sub Lease Change Renew Lease Terminate & Move Out REAL ESTATE ADMIN SYSTEM Integration between systems ENTERPRISE LEASE ACCOUNTING Page 30

Integrating Real Estate & Accounting Systems Potential options if your real estate system may not hold the lease data needed for accounting 1 Use a 2 Customize Your Real 3 Template Estate System Manual Adjustment at Close Store the lease data fields that the real estate system cannot hold in a spreadsheet Customize the real estate system to hold the data needed for lease accounting Manually enter the needed data into the Accounting system at monthly close Page 31

One Lease Two Views Accounting Data & Terminology Cost Center Allocation Lease Incentives Right-of-Use Assets Non-Lease Components Variable Rent Chargebacks Real Estate Data & Terminology Tenant Improvement Allowances, Work Letter, Moving Allowance, etc Parking, Storage, Individually Identifiable Floor Spaces A good or service that is not the ROU asset Rent that is unknown, like percentage rent or contingent rent Page 32

Additional Resources Cost Savings Opportunities in Real Estate Lease Administration Differences between Real Estate and Equipment Leases Separation Anxiety Lease and Non-Lease Components Page 33

THANK YOU QUESTIONS? LeaseAccelerator LeaseAccelerator @LeaseAccelerate www.leaseaccelerator.com LeaseAccelerator