Understanding Leasehold Improvements Under ASC 842

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Implementing the new lease accounting standards under ASC 842 is a daunting task. Multiple complexities will emerge while you go through the compliance process, and accounting for leasehold improvements is one of them. 

What Are They?

Leasehold improvements refer to any changes, modifications or additions done to a leased space by the tenant. Landlords can agree with the improvements for the current tenant or a new one. It may range from customizing the interior design of the space, installing partitions temporarily to permanently improving the utility or look of the property, electrical installations, flooring, etc. However, it is important to note that certain changes like elevators, roofs, fire protection and security systems do not come under leasehold improvements. 

What’s the Change?

Leasehold improvements are recorded as property, plant and equipment assets on the balance sheet. According to the new lease accounting standards ASC 842, they are handled in the same manner. However, when the tenant uses the leasehold improvements as a tenant improvement allowance, it demands a different treatment in accounting. 

Tenant Improvement Allowance

A tenant improvement allowance (TIA) is one of the types of leasehold improvements that authorizes the tenant to take up the improvement project without the involvement of the landlord. Generally, the budget and other provisions regarding improvements are covered in the lease, including who makes payment, whether it’s made to the service provider directly or as a reimbursement to the tenant, and so on. A tenant may choose to use their TIA to pay for leasehold improvements, one of the ways landlords use to attract tenants. 

Accounting for the TIA depends on different factors, such as when ownership of the improvement transfers from lessee to lessor and the flow-through arrangement. As mentioned under ASC 842, accounting for tenants using leasehold improvements as tenant improvement allowance is different. Given that the TIA is paid to the tenant when the agreement is made, it is supposed to be treated as a lease incentive that minimizes the Right of Use (ROU) asset. Moreover, in cases where TIA is not received, lease liability is reduced for minimum lease payments made in the future. Thus, there is a lower lease cost and a separate expense every month related to leasehold improvement for tenants. 

In summary, it is important to note that leasehold improvements are not impacted much under ASC 842 new lease accounting standards. However, there are implications for lease incentives and tenant improvement allowances for every lease agreement. Tenants should keep an eye on the expenses related to leasehold improvements as the assets can be amortized. Also, lease improvements and incentives are critical details that need to be analyzed for better lease accounting and successful compliance with ASC 842. A lease accounting software and lease management software can help in the analysis, tracking and reporting of critical details. 

Yardi Corom is a simple and comprehensive accounting, lease and workplace management solution for CRE tenants. Our cloud-based software solution increases efficiency and accuracy across your entire lease portfolio: manage leases and subleases, track key lease data, centralize transactions and become FASB/GASB/IFRS compliant. To learn more, you can visit our website or schedule a meeting with our team.