Discussion:Lease incentive accounting (cash for Leasehold improvements)
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| 4 January 2008 | |
| Can't figure out which is the right way to account for an upfront "reimbursement" of $100k from lessor to lessee for expenses lessee incurred and paid out of their own pocket for upfitting and adding leasehold type improvements to a new facility. It's a 5 year lease.
Here's what I'm thinking: They have been capitalizing the leasehold improvements as fixed assets (depreciate over 5 years for book). Book the $100k as Lease Incentive (credit/liability account) and write it down straight line over the life of the lease (reducing lease expense). I gues smy other option is to decrease the leasehold improvement costs directly with the $100K (allocating among the improvements in some manner). Either way the bottom line is the same on the P&L, but the balance sheet is affected by the decision. Any thoughts? | |
| January 4, 2008 | |
| Why do you call it an "upfront" reimbursement if the funds have already been expended by the lessee? Does the lease address the issue of which improvements it covers? The bottom line will be impacted differently depending on how the reimbursement is applied. Let's say it is applied first to improvements with the longest life. That would result in a different depreciation amount than if it is applied to items with the shortest life first. | |
| 4 January 2008 | |
| Here's what I'm thinking: They have been capitalizing the leasehold improvements as fixed assets (depreciate over 5 years for book). Book the $100k as Lease Incentive (credit/liability account) and write it down straight line over the life of the lease (reducing lease expense).
You have the correct answer. Leasehold incentives were the source of a lot of restatements for restaurants and retail companies about 3-4 years ago. Book a liability and amortize it using the life of the lease plus any renewals allowed in the agreement that are expected to be utilized. I read an article in fall 2006 about this - I think it was on AccountingWeb. Maybe to a search for it to get more background. | |
| 4 January 2008 | |
| To clarify the restatements were because it became industry practice to net the incentive against the improvements. This was discovered during one of the first rounds of PCAOB inspections if I recall. | |
| 4 January 2008 | |
| I did find this article which was very interesting: http://www.thespaceplace.net/articles/hennigh200503.htm
It discussess the tax implications of such a situation. It seems that UTdave1 if I account for the incentive amount over 5 years (life of lease), the IRS is going to want all of it $100k to be recognized at income on the cash basis. Which, actually as of today the amount has not been received by the lessee, but the taxpayer is accrual basis so there would be a receivable for the $100k @ 12/31, but not received until 2008, so I assume I can go with the "cash method" for reporting the whole $100k incentive it seems to me. | |
| 4 January 2008 | |
| Natalie, the improvements were by contract to have been paid by the Lessor in the construction of the building. Construction seemingly as it does, took longer than expected and the lessee actually "moved" in before completion of the upfit. It got to be a situation where these upfit items were necessary to be done expeditiously so there was thought to be no choice by the lessee but to pay for them themselves and get "reimbursed" for them at a later time. The lease speaks of terms like "allowance" and "reimburse" when discussing these upfit items (some of which are interior walls to creat office space, built in cabinets, air handling and HVAC units... stuff that won't be going with them if they move at the end of the lease.
The lease does address a myriad of improvements that it covers, but some of those items have changed (verbally and actually) when the construction was done by some of the subcontractors. Taxwise...What seems to be most important is how "ownership" of these LH improvements is viewed. I'd rather the Lessee "own" them since they paid $100k for them and we (the lessee) can just do an adjustment to certain items that we know aren't mobile (like the interior walls etc.) GAAP wise... Sounds like it should be a lease incentive that would be spread over the life of the lease. | |
| 4 January 2008 | |
| I'm interested to hear what others have to say regarding the tax implications of this issue. | |
| January 5, 2008 | |
| Thanks for the clarification. I think it is generally more beneficial to own the improvements as you state (think Sec. 179, etc.). I, too, am curious what others have to say. | |
| 5 January 2008 | |
| Natalie, I agree about the 179 on the owned property however, if the IRS is going to definitely make me recognize all $100k as income immediately and record the LHImpv. as assets on our (lessee) books, then some of those longer lived assets I don't think would be elegible for 179. Most will be 15 yr life for tax purposes aren't they even though the lease is 5 yrs. Now of course I will try to class as much as possible into the 5-7yr equipment category, but I can't do that with office walls I don't think. | |
| 25 March 2008 | |
| Here's a very informative article from 2005 on the tax treatment of construction allowances:
http://www.thespaceplace.net/articles/hennigh200503.htm Seems that for a very broadly defined "retail space" lease of less than 15 years, a lessor-owned leashold improvement (realty improvements only) are covered by a lessee safe harbor so that an allowance, as long as it is less than expenditure and spent within 8 1/2 months beyond the end of the tax year in which it was disbursed are considered essentially as a pass-through of lessor money. For GAAP, all leasehold improvements should be booked as assets and amortized over the lesser of lease term or useful life and such amortization should be offset against the lease expense. Here's an SEC statement from 2005 on their interpretation of FASB for public companies: http://www.sec.gov/info/accountants/staffletters/cpcaf020705.htm I have read elsewhere (http://www.answers.com/topic/leasehold-improvement?cat=biz-fin) that leasehold improvements in excess of the allowance (since the allowance is a pass-through) are, from a tax perspective treated as assets and amortized over the lease term but that the amortization expenses are not deductible.
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RoyDaleOne (talk|edits) said: | 18 April 2008 |
| It got to be a situation where these upfit items were necessary to be done expeditiously so there was thought to be no choice by the lessee but to pay for them themselves and get "reimbursed" for them at a later time.
Does this comment mean that the lessor was to pay, or provide these improvements? The lessor paid for items to expedite the construction and was due reimbursement because the items were the lessor's responsibility? If the forgoing is correct you have nothing but a simple loan from the lessee to the lessor. | |
| 25 September 2008 | |
| My question is when you get the cash you Dr cash and Cr Liability. When you pay the bills for improvements you cr cash and dr liability. Then you have to also Dr some asset to depreciate. How does this work?
Neil | |
| 30 September 2008 | |
| GAAP:
Entry to receive cash: Cash 100,000 Deferred Rent (100,000) To pay for improvements: Leasehold improvements xx,xxx Cash (xx,xxx) Amortize the deferred rent over the term of the lease plus any renewal options expected to be used. Depreciate the leasehold improvements over the shorter of their useful life or the term of the lease plus any renewal options expected to be used. See FTB 88-1 for guidance. Additionally, the NY CPA Journal had an article about this in Dec of 2006 that you can access online. | |
| 22 October 2009 | |
| If the landlord owns the improvements, then I would think that the landlord would depreciate the improvements and you would not want both landlord and tenant to depreciate the same asset. I agree about the amortization of the deferred rent liability for the cash allowance for GAAP. On the books, this amortization would seem to increase the taxable income of the entity unless another entry is made to offset the reduction in rental income. For the LHI which the tenant paid for (and got reimbursed for) should these amounts actually be booked as rent expense, i.e. decreasing the amount of depreciable LHI on the tenant's books and also increasing the rent expense back to where it was to offset the reduction in rent expense caused by the amortization of the TI allowance? | |
