Financial Watch
Accounting for
Contingent Rents
Lease accountants face a change in the way they record contingent rents.
T
he popularity of contingent rents in lease contracts has
focused renewed attention on the impact of contingent
rents on lease classification and income recognition. Both
the Emerging Issues Task Force of the FASB and the SEC
have examined the issues surrounding the recognition of
contingent rents by lessees and lessors to address concerns
over divergent practices in the leasing industry. A lease
agreement may call for a lessee to pay a fixed base rent and a
contingent rent based upon specified sales volume, equipment usage, or interest rates for a period
or as of a specific point in time. Of particular concern is the question of when
to recognize contingent rentals in financial statements if the factor, which
triggers a decrease or increase in rental
payments, cannot be ascertained until a
subsequent period.
WHAT ARE CONTINGENT RENTS? A lease
agreement may call for a lessee to pay a
fixed base rent and a contingent rent
based upon specified sales volume, equipment usage, or index for a period. The
lease accountant must consider the
amount and nature of these contingent
payments for both lease classification and
income and expense recognition.
Contingent rents are defined in SFAS
#29, as the increases or decreases in
lease payments that result from changes
occurring subsequent the inception of
the lease in the factors (other than the passage of time) on
which the lease payments are based, except for changes in
construction or acquisition costs.
LEASE CLASSIFICATION. Contingent rents need to be considered when calculating minimum lease payments for the 90%
test, which determines whether a lease is considered to be a
capital or an operating lease. Contingent rents based upon a
factor which is known at lease inception such as an interest
rate index are to be included in minimum lease payments
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• September 2000
The lease accountant must
consider the amount and nature
of contingent payments for both
lease classification and income
and expense recognition.
using the index in effect as of lease
inception. Contingent rents based upon
the future usage of the asset may be
omitted from minimum lease payments.
Rents based upon sales volume are often
considered contingent and are omitted
from minimum lease payments. However,
accountants may challenge some contingent factors if the factor is not clearly
related to the actual use of the asset
being leased such as general corporate
sales volumes. In addition, accountants
may not regard rentals as being truly
contingent if the base rent in the lease is
insufficient to make the transaction economic on its own.
REVENUE RECOGNITION. Contingent
rentals are frequently determined for a
period based upon a factor or index,
which is not yet known. For example,
rentals for the period ended June 30, 2000, may be based upon
a sales target for the year ended December 30, 2000. Should
contingent rentals be estimated and recorded for the interim
period ended June 30, 2000? The Emerging Issues Task Force
(EITF) of the FASB clarified the timing and the manner in
which lessees should account for contingent rental expense in
EITF Consensus #98-9, Accounting for Contingent Rent.
Lessor recognition has been more controversial. The SEC
issued Staff Accounting Bulletin (SAB) #101 to address con-
Of particular concern is the
question of when to recognize
contingent rentals in financial
statements.
cerns over lessor recognition of contingent rents. SAB 101 has
been amended twice, most recently on June 28, 2000.
LESSEE REVENUE RECOGNITION. Lessees should recognize
contingent rental expense in both interim and annual financial
statements based upon whether it is probable that a specified
target will be achieved. If the target is subsequently not met or
if it becomes probable that a target will not be met, then the
lessee should reverse any overaccrual of rental expense at that
time. SFAS # 13 also requires that the lessee disclose in the
financial statements the amount of contingent rent and its
policies regarding the recognition of contingent rent.
LESSOR REVENUE RECOGNITION . Lessors, however, should not
recognize income for contingent rentals until the related target has actually been achieved, regardless of probability in
accordance with SAB 101. Reacting to increasing concerns
over aggressive revenue recognition on the part of lessors,
among others, the SEC issued SAB 101 in December of 1999.
Although practice has varied, it was previously not uncommon for lessors to recognize contingent rental income based
upon the probability that a target would be achieved. This
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• September 2000
practice was not inconsistent with SFAS # 29 or SFAS# 5,
Accounting for Contingencies. To address concerns in the
industry over the impact of an accounting change to many
registrants impacted by SAB 101, the SEC issued amendments, SAB # 101A and SAB 101B, to delay the required
implementation date.
Implementation for companies reporting a change in
accounting policy due to SAB 101 must be completed no later
than their fourth fiscal quarter of their fiscal year beginning
after December 15, 2000. For a calendar year-end company,
this would be the quarter ended December 31, 2000. For a
company with a fiscal year-end of April 30, 2000, this would be
the fourth quarter ending April 30, 2001. If a change were
made during a fiscal year, restatement of prior interim periods
would be required.
ELT thanks Patricia A.Donoghue , BTM Capital Corporation,Boston, for this
month’s column.