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PwC Warns Companies on Build-to-Suit Lease Traps

Tammy Whitehouse | May 30, 2012

As companies consider expansion plans coming out of recession, PwC is advising them to pay careful attention to the accounting implications around any construction activity they may undertake.

During a recent webcast covering a variety of accounting issues, PwC Partner Chad Soares reminded companies that there are unpleasant balance sheet implications to beware when entering into build-to-suit lease agreements. PwC recently clipped the the audio containing Soares' 8-minute explanation out of the webcast and circulated it as a stand-alone podcast. “If a lease involves an asset that will be constructed, special rules exist,” he warns. “And those rules, if not complied with, can actually result in you characterizing the leased asset as if you were the owner.”

An asset acquired under today's rules for operating leases is treated as no asset at all on the balance sheet and a straight-line expense on the income statement. If a company were to acquire the asset, however, it would record an asset and a liability on the balance sheet and a debt obligation to be taken down over time through the income statement. Companies could find themselves treating lease improvements as asset acquisitions if they're not careful, Soares said.

The rules, found in Accounting Standards Codification 840-40-5, address the extent to which a company has a continuing involvement in a particular asset as it is constructed. The situation could arise as a company renovates or expands an existing piece of property or even rebuilds a piece of property after some kind of calamity, Soares said, although that may be readily apparent to companies sometimes as they read the guidance.

The criteria or factors that will cause a particular construction project to be treated as a lease or an owned asset depend are both qualitative and quantitative, Soares explained. On the qualitative side, criteria include, for example, whether a company is paying for a construction project directly without no unconditional right of reimbursement. “That's enough to make you the accounting owner,” he said. “There are very few areas of (Generally Accepted Accounting Principles) where a single dollar is determinative of the accounting outcome, so that's certainly something to be aware of.”

On the quantitative side, Soares said companies need to be aware of the “maximum guarantee test,” which imposes a cap on the financial responsibility that a lessee would accept and still treat the obligation as a lease. “If you exceed it, you could find yourself having this on the balance sheet as the accounting owner,” he warned.