With the revenue recognition changes managed, many corporate accounting teams are now turning their full attention to implementing the new FASB & IFRS lease accounting standards. While the overall goal is clear, we are hearing many questions about the details. Today we’ll address two frequently asked questions about lease accounting implementation: accounting for real estate CAM charges, and accounting for leasehold improvements.
Real Estate CAM (common area maintenance) accounting
What are CAM expenses?
Common area maintenance or CAM fees are common in commercial real estate leases. CAM charges 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 property. Retail property such as shopping centers will have different charges particularly relating to open areas, versus office space that will have minimum open areas.
Common area maintenance accounting under the new standards
In terms of the new lease standard impact, real estate CAM charges are not included in the asset value of the lease. 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.
A final consideration in the topic of common area maintenance accounting is the issue of reconciliation. This 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
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” that 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.
Accounting for leasehold improvements under GAAP
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. LHI is an asset but is not included in the calculation of the tenant’s total lease asset per the new FASB lease standard.
CAM and leasehold improvements: impact on leasing strategy
CAM and LHI are two areas of lease management that require careful and diligent attention. Both areas are subject to negotiation, and CRE managers should strive to leverage these factors to their advantage during initial lease negotiations. Fortunately the new lease standards will not affect CAM or LHI investments adversely, but careful attention to these factors could pay dividends over the term of the lease.