Key Money and the Impact on Lease Accounting Under ASC 842

Key money is typically used in the leasing industry to describe an incentive paid to acquire a lease. And it’s a term that can make auditors a little nervous. 

Key money can have different meanings in different parts of the world. Sometimes it could be used to refer to a bribe or another “under the table” payment.

However key money can also refer to completely legitimate and even common practices in leasing. In fact, some large companies operating under ASC 842 lease accounting standards, audited by well-known accounting firms, even have a key money account on the general ledger. 

Prepping for your next audit?

Pay attention to these critical factors

Prepping for your next audit?

Example of Key Money in Retail Lease Deal

For example, consider a fictional scenario in which Burger Barn (BB) wanted to occupy a space in Ritzy Mall (RM). BB and RM agree to lease terms, but there is one problem, Pretzel Depot (PD) is in the space that BB wants, and the PD lease is locked in for another two years. 

Now, BB may want to choose a less desirable and currently available location in RM. Or BB may decide to offer PD an incentive to move out early. You could refer to that incentive as “key money.”

Retail today ...

What's working and what isn't?

Retail today ...

Key Money and ASC 842

ASC 842 addresses this type of payment in the excerpts shown below. Basically, a payment of key money in this context should become a part of the right of use (ROU) asset, which will then be amortized over the term of the lease. It does not impact the lease liability, because the key money has already been paid.   

842-10-30-9 Initial direct costs for a lessee or a lessor may include, for example, either of the following:

a. Commissions

b. Payments made to an existing tenant to incentivize that tenant to terminate its lease.

842-20-30-5 At the commencement date, the cost of the right-of-use asset shall consist of all of the following:

a. The amount of the initial measurement of the lease liability

b. Any lease payments made to the lessor at or before the commencement date, minus any lease incentives received

c. Any initial direct costs incurred by the lessee (as described in paragraphs 842-10-30-9 through 30-10).

Recording key money is one of many scenarios that will require an adjustment to the ROU asset under ASC 842. Other examples include:

• Other direct costs such as commissions
• Lease incentives received at or before lease inception
• Impairment of the ROU asset
• Prepaid or Accrued lease payments
• Deferred rent (from ASC 840) upon transition to ASC 842

When evaluating lease accounting solutions, make sure ROU asset adjustment functionality is in place and easy to use. Don’t be caught off guard with a lease accounting software provider that does not offer the functionality needed for smooth and efficient ASC 842 compliance.