New Lease Standard – Focus on Executory Costs

By | March 16, 2016

One of the areas of the new lease standard that has not received that much attention is executory costs. However, as lessees consummate new leases that must be transitioned into the new standard, this is an area that should not be overlooked.

Executory Costs that Transfer a Good or Service

The new lease standard only covers the accounting for leases. Therefore, any non-lease components that transfer a good or service to the lessee (other than the right to use the asset) and that are contained in the lease payment should generally be accounted for separately. The new standard provides lessees with two options in this instance. From a practical standpoint, the lessee can make an accounting election to account for any non-lease component as part of the lease to which it relates. This election will result in a larger Right to Use (“ROU”) Asset and Lease Liability that must be recognized. Otherwise, the lessee must separate the lease and non-lease components and value each component on a relative stand-alone basis. This approach will result in a smaller ROU Asset and Lease Liability but will require additional effort in determining the relative stand-alone value of each component and the accounting required for each component.

One common example of a non-lease component (good or service) that might be bundled into the contractual payment to the lessor is maintenance services. In the future, lessees should consider contracting separately for services such as these thereby eliminating the need to derive a stand-alone value for the non-lease component.

Executory Costs that do not Transfer a Good or Service

Some executory costs such as payments for property taxes and insurance do not transfer a good or service and, therefore, are not components of the contract. To the extent that the lessee is responsible for some or all of these lessor ownership costs, it is important that the consideration for these costs is structured in the best interest of the lessee

Lessee payments for lessor ownership costs that are structured as fixed payments will be included in the present value calculation of the unpaid lease payments resulting in a larger ROU Asset and Lease Liability. Structuring these types of lessor payments as a direct pass-through of the lessor actual costs will generally categorize them as variable payments and eliminate them from the calculation of the ROU Asset and Lease Liability.

Final Thoughts

The accounting for executory costs under the new lease standard is more complicated than has been the case under previous generally accepted accounting standards. Now is the time to consider these requirements as new lease contracts are negotiated.

 

We at iLease Management LLC believe that the lease technology solution that is selected is a critical element of the transition to the new accounting model. Bringing together all the elements of Lease Analysis, Lease Management and Lease Accounting in one technology solution allows an organization to capture efficiencies that should be a byproduct of new technology adoption. That is why we developed our lease technology solution, iLeasePro. To get more information on the lease accounting change and iLeasePro, please go to our website at http://www.ileasepro.com