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Understanding Non-Lease Components - DebtBook

Written by Kasey Harris | Oct 4, 2021 9:44:00 AM

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.

Guidance in GASB 87

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?

Lease vs. Non-Lease Components

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.  

Deep-Dive: Real Estate Leases

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:

  • Absolute Net Lease - Often, the tenant is responsible for a majority if not all expenses, including insurance; taxes; and maintenance, repair, and replacement of the structure, roof, and parking lot
  • Triple Net Lease - Often, the roof and structure are covered by the landlord, and operating expenses, or TICAM (taxes, insurance, and common area maintenance), are pushed to the tenant. The tenant also usually pays their own janitorial services, interior maintenance and repair expenses, and utilities.
  • Modified Gross Lease - Often, the landlord takes on roof and structure maintenance, as well as TICAM, while the tenant can incur any or all of the following expenses: janitorial services, interior maintenance expenses, and utilities.
  • Full Service Lease - Often, the landlord estimates and bills all of these expenses in one rent check, with the exception of telephone, internet, and data expenses. Base rent, TICAM, janitorial, and electric are all direct pass throughs in one check under this scenario. 

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.

Allocating Contract Price to Lease and Non-lease Components

There are two primary methodologies for allocating the contract prices to the different types of components:

  1. Using price-related information that is outlined within the contract

  2. Using the best available information and professional judgement to determine the best estimate

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.

 

 

How Lease Management Software can Help

GASB 87 does not offer a list of lease and non-lease components. For every lease, organizations need to perform the following:

  1. Identify the lease and non-lease components

  2. Determine the fair value of each lease and non-lease component and allocate the contract price appropriately

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!

 

 

Disclaimer: DebtBook does not provide professional services or advice. DebtBook has prepared these materials for general informational and educational purposes, which means we have not tailored the information to your specific circumstances. Please consult your professional advisors before taking action based on any information in these materials. Any use of this information is solely at your own risk.