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An SEC View On Lease Accounting Do-Overs

Feb 9

Written by: Jack Ciesielski
2/9/2005 2:04 PM

On February 7, SEC chief accountant Don Nicolaisen sent a letter to the AICPA's chairman of its "Center for Public Company Audit Firms" outlining the staff's thoughts on the accounting issues involved in the recent rash of leasing do-overs. The letter was cc'd to the chief accountant of the SEC's Division of Corporation Finance, the chairman of the FASB, and the AICPA's SEC Regulations Committee. (I'm a member of that one.)

Nicolaisen reminded readers of the proper accounting for three particular lease issues:

1. The mismatch issue: Don't depreciate leasehold improvements over a longer period than the contract term for the leased property. (See Target and others.)

2. The "rent holiday" issue: If a rental agreement contains scheduled increases (sometimes called a "rent holiday": you can tailor the scheduled payments to match the lessee's cash flow, making for a near-term holiday for the cash-strapped), work the escalations into the total minimum rentals, to be recognized on a straight-line basis over the lease term as part of the rental expense.

3. The lessor leasehold improvement incentive issue: If a lessor picks up the tab for leasehold improvements the lessee will use, as bait to sign the lease, the lessee should account for the expenditure as deferred rental revenues - not by netting it against the cost of leasehold improvements. The deferred rental revenues should be amortized against rental expense over the lease period.

The first two issues have been well covered by now. The third one - the incentive issue - surfaced this morning with Borders Group. Maybe they read Nicolaisen's letter on Monday. Or maybe Nicolaisen wrote the letter after the SEC staff worked with Borders and their auditors. Doesn't matter, really.

Letters like these aren't exactly dictations of new accounting standards - indeed, there's nothing new in this letter. It's a cross-reference to existing standards. Letters like these, however, do find their way into the think tanks of auditing firms - hence the distribution to the AICPA's Center for Public Company Auditors and its SEC Regs Committee. Theoretically, they'll become part of the audit planning/follow-up throughout all auditing firm's clients.

Yes, it's a rickety, might-miss system, but it still will be likely to generate a lot more of these lease accounting do-overs. Keep tuned.

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