Case Study ABC Inc

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ABC Inc. Date: January 11th, 2015 Prepared by: Reviewed by: Professor ISSUE: Accounting for ABC’s tenant improvements and lease incentive obligations under the lease agreement with Landlord LLC (the “Landlord”). BRIEF BACKGROUND OF COMPANY ABC Inc. was founded in 2007 and is headquartered in San Francisco. Revenues and net income for 2010 are $500 million and $80 million, respectively. In September 2010, ABC Inc. (“ABC” or the “Company”) entered into an agreement with Landlord LLC (the “Landlord”) to lease approximately 268,000 square feet or 40% of a building located at 100 Smith Street, San Francisco. The building was originally configured to be used as office space. However, ABC wished to re-configure the interior layout…show more content…
For the tenant improvements, ABC will be responsible for any expenses above $13 million. The Landlord is giving ABC the tenant improvements as a tenant incentive. The incentive is for ABC to sign a long term lease. The original lease term extends for 7 years from the inception date. In addition, the lease contains two 5-year renewal options, the first at 95% of fair value at the time of renewal. The lease also includes an early termination option (for a fee) relating to certain floors after 5 years for one floor and after 6 years for 2 additional floors. QUESTION 3 What are the risks with tenant improvements? ABC will assume the risk and expenses of construction overruns. Refer to ASC 840-40-55-2 for Criteria for Determining Whether the Lessee Should Be Considered the Owner of the Asset Under Construction. The risk will increase if the Landlord does the construction. The Landlord has little to no incentive to keep costs within the agreed tenant improvement amount since the Landlord does not have to pay for any excess. For this reason, it may be preferable for ABC to suggest another way to handle tenant improvements. QUESTION 4 How does ABC account for tenant improvements? Even though there is no rent during the construction period, ABC will need to record rent expense. ABC will need to set up a deferred asset account and adjust it to achieve the straight-line rent expense. Refer to ASC
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