In attempt to become compliant with lease accounting standards, particularly ASC 842 and IFRS 16, there are many intricate details that accountants often have questions about. Today we’ll address accounting for real estate CAM charges, and leasehold improvements.
What are CAM expenses?
Common area maintenance (CAM) fees are common charges in commercial real estate leases. Charged in addition to rent, average CAM fees cover the lessor’s operational expenses including maintenance, janitorial, repairs, snow removal, landscaping, etc.
Tenants are charged their pro-rata share of these charges on an annual basis. Specifically, the tenant’s share would be the percentage of the tenant rentable space to the total rentable space of the property.
Real estate CAM charges vary according to the type of real estate property. For example, retail property such as shopping centers will have different charges particularly relating to open areas, versus office space that will have minimal open areas.
Accounting for CAM Charges
Real estate CAM charges are not included in the asset value of the lease. Instead, they are expensed in the year they’re incurred. It’s important to scrutinize CAM charges to be sure that capital costs are not included in the expenses. This is a frequent error and thus tenants must be vigilant that capital costs are not included in the CAM charges.
Another key factor in CAM charges is the issue of establishing a cap and floor to the charges. CAM charges can fluctuate and thus it’s important to establish limits on the degree by which the charges can extend.
What is CAM Reconciliation?
CAM reconciliation is the process of reconciling estimated charges with actuals. Typically, an audit of the CAM charges is made at the end of the fiscal year and the differences between estimated versus actual costs are calculated. Either the landlord or tenant are made “whole” through the reconciliation process.
Accounting for Leasehold Improvements
Leasehold improvements are considered an asset but are treated differently from other leased assets under ASC 842. Although leasehold improvements are recorded as assets on the tenant’s balance sheet, they are not included in the calculation of the total lease asset or liability, which focuses on the right-of-use asset and lease liability.
Instead, leasehold improvements are capitalized separately and depreciated over the shorter of the lease term or the useful life of the improvements. This means that while they are excluded from the lease asset calculation, they still impact the tenant’s financial statements through depreciation expenses. It’s also important for tenants to keep track of any leasehold improvement allowances provided by the landlord, as these can affect the accounting treatment of both the improvements and the lease payments.
How Do CAM Fees Impact a Lease Agreement?
CAM and LHI are two areas of lease management that require careful and diligent attention. Both areas are subject to negotiation, and your organization should strive to leverage these factors to their advantage during initial lease negotiations.
Managing CAM fees and leasehold improvements can be complex and time-consuming, especially when dealing with multiple leases or properties. Lease accounting software, like Visual Lease’s, can simplify this process by automating the tracking, calculation, and reporting of CAM fees and leasehold improvements. This software provides insights into how CAM fees are structured and helps tenants monitor any changes or increases.
Lease accounting software can also track the cost of leasehold improvements, and ensure they are correctly capitalized and depreciated in line with accounting standards. By automating these processes, businesses can improve financial accuracy, reduce manual errors, and ensure compliance with lease accounting standards.
How CAM Fees and Leasehold Improvements Are Linked in a Lease
CAM fees and leasehold improvements are often connected, especially when leasehold improvements impact common areas of a building. For example, if a landlord renovates shared spaces such as lobbies or exterior areas, the costs for these improvements may be passed on to tenants through increased CAM fees.
Tenants should review their lease agreements to understand how improvements to common areas will affect their CAM charges. If a tenant makes leasehold improvements that benefit the overall property, there may be room to negotiate a reduction or offset in CAM fees.
What are leasehold improvements?
Leasehold improvements (LHI) are defined as capital improvements made to a tenant’s space such as dry wall, electrical, carpeting, lighting, etc. Most office leases offer what is called a “work letter”, which defines what the building owner will provide to the tenant in terms of basic improvements. These improvements can be offered as a credit in the rent or provided separately.
Leasehold improvements are typically provided over and above the building allowance. The tenant will typically amortize the improvements over the term of the lease, and in most cases the improvements revert to the building owner upon lease termination.
Learn more: Lease Portfolio Management: Policies and Procedures to Reduce Risk
