What You Need to Know About Executory Costs Under ASC 842
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.
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