Amie Sweeney 2017-01-20 03:59:05
BUILD-TO-SUIT LEASE ARRANGEMENTS are efficient means for companies to access expensive assets. A user becomes a lessee when it signs a lease on an asset to be built—think of a commercial airplane, an ocean-going freighter or a corporate headquarters building. These assets are all essential components of the businesses, but are far too costly for most companies to simply write a check. These purchases can be financed through a variety of loan products, but most will require a sizable cash outlay. Additionally, the outflow of funds will likely be made well in advance of the completion of the asset. Leasing a build-to-suit asset, in many cases, may prove to be the best vehicle for users to gain access to assets otherwise out-of-reach because the lessor-owner funds the construction. Further, rent on the asset does not commence until completion of construction and the lessee gains use of the asset.
Entering into a build-to-suit arrangement allows a lessee to tailor the asset to its needs and lease it upon completion. Ideally, the asset will never appear on the lessee’s balance sheet and will be classified as an operating lease. However, if the onerous rules found in ASC 840-40-55 are not followed, the asset will be capitalized on a lessee’s balance sheet during construction, even if title to the asset never passes to the lessee. If capitalization occurs, sale-and-leaseback accounting must be used at the completion of construction to determine if the asset can be derecognized and a lease classified. The current accounting model is based on risk, and capitalization occurs if the lessee is deemed to have substantially all the risk during construction.
Build-to-suit rules are considered under Topic 842, but use the principles addressed in Topic 606, the Revenue Recognition standard. The new model changes the focus to determine whether the lessee controls the asset being constructed. If the lessee controls the asset, it must be capitalized. The following are examples that can be deemed control by the lessee:
The lessee has the right to obtain the partially constructed asset at any point during the construction period, for example, by making payment to the lessor.
The lessor has an enforceable right to payment for its performance to date, and the asset does not have an alternative use to the owner-lessor.
The lessee legally owns the land and property improvements, a building and the land on which it stands, or the non.real estate asset, like a ship or an airplane, which is under construction.
The lessee controls the land that property improvements will be constructed on and does not enter into a lease of the land before beginning construction that, together with renewal options, permits the lessor or another unrelated third party to lease the land for substantially all the economic life of the property improvements.
The lessee leases the land upon which the property improvements will be constructed, and the term of the lease, together with lessee renewal options, is for substantially all of the economic life of the property improvements, and the lessee does not sublease the land before the beginning of construction for at least the same time period as the lessee’s control of the land.
If a lessee is deemed to control the construction of a leased asset, the asset will be capitalized on the lessee’s balance sheet. At the end of construction, the lease will be subject to the sale-and-leaseback accounting requirements of ASC 842 to determine the future accounting treatment of the transaction.
When Topic 842 goes into effect, all buildto- suit leases, like virtually all leases, will be capitalized on the balance sheets of lessees. If a lessee is not the owner of a build-to-suit asset during the construction period but makes payments during construction, the payments are accounted for based upon their nature. Payments made for the right to use the underlying asset are lease payments, regardless of the timing or form of those payments, and therefore recorded as prepaid rent. Conversely, costs incurred by the lessee that relate specifically to construction or design of an asset that are not payments for the use of an asset to be leased are recognized in accordance with other U.S. GAAP.
Transition from today’s ASC 840 to tomorrow’s ASC 842 may bring some welcome relief for lessees. Build-to-suit leases are subject to the same modified retrospective transition approach as all other leases.
The modified retrospective approach will be applied to all build-to-suit lease arrangements that exist at or are entered into aft er the date of initial application but before the effective date.
Entities that recognized assets and liabilities solely as a result of the build-tosuit guidance in ASC 840 are required to derecognize the assets and liabilities at the later of the date of initial application or the date that the lessee was determined to be the accounting owner of the asset under ASC 840’s build-to-suit guidance.
Any difference between the amounts of the assets and the liabilities derecognized is recorded as an adjustment to equity at that date. The lessee then follows the general lessee transaction guidance for the lease.
Today’s ultralow interest rate environment has made build-to-suits attractive for users of large expensive assets. And, unlike most lessees who feel the new lease accounting standard will be a burden to them, build-to-suit lessees will find relief under the new guidelines. Under ASC 842, it is likely that fewer lessees will determine that they are the accounting owners of assets being constructed than is the case under ASC 840. These two factors should spark additional build-to-suit activity.
Amie Sweeney is Vice President, CBRE Group, Inc.and a member of the Financial Accounting Committee.
Thanks to Bob Malinowski, Executive Director, Ernst & Young LLP, for his contributions to this article.
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