Construction adds complexity to lease accounting

Companies that undertake construction projects along with leases must take care of the accounting effects. Certain projects must be included as an asset in the Tenant Balance, depending on their degree of relationship with the project. If the lease involves an asset that will be built, there are special rules.

An asset acquired under the current rules for operating leases is not treated as an asset in the Balance Sheet and a straight line expense in the income statement. If a company acquired the asset, however, it would record an asset and a liability in the Balance Sheet and a debt obligation to be reduced over time in the income statement. Companies may be recording improvements in leases as assets acquired if they do not have the necessary care, Soars said.

The standards, found in Accounting Standards Codification, cover the extent to which the company is continually involved in a specific asset during its construction. The situation could arise if the company decides to renew or expand an existing property or rebuild part of a property after a calamity.

The criteria or factors that would cause a particular construction project to be treated as a lease or own asset depend on whether they are qualitative.

On the quantitative side, that companies must take care of the “maximum guarantee test”, which imposes a limit on the financial responsibility that the lessee would accept and the obligation would still be treated as a lease.