Retail Lease Management and Accounting Standards
Retail tenants have a large number of operating leases and are significantly impacted by the ASC 842 lease accounting standard. Retail companies lease a variety of assets, ranging from brick-and-mortar store locations to distribution centers, vehicles, IT systems, and equipment. Sometimes, retailers even also act as lessors.
Because of this complexity and scale, retail lease accounting requires careful attention to industry-specific accounting practices, lease requirements, and ongoing portfolio changes. Below is a high-level overview of how lease accounting standards affect retail tenants and what makes retail leases unique from an accounting perspective.
What Is a Retail Lease?
A retail lease is a contractual agreement that allows a retailer to use a physical location or asset in exchange for payment over a defined period of time. Most retail leases involve real estate—such as mall storefronts, shopping centers, or standalone locations—but may also include warehouses, distribution centers, or specialized equipment.
Retail leases often contain unique terms that differ from other industries, including:
These features influence how retail leases are measured and reported under current accounting standards.
Retail Industry Accounting Standards and ASC 842
Retail industry accounting standards require companies to recognize most leases on the balance sheet under ASC 842. This includes recording a right-of-use (ROU) asset and corresponding lease liability for operating leases that were previously disclosed only in footnotes.
It is easy to overlook embedded leases that now must appear on-balance sheet. Retail leases can include everything from real estate leases for individual stores and distribution centers to vehicle leases, IT systems and office equipment leases.
For retailers with hundreds or thousands of leases, identifying and accounting for these arrangements can be a significant challenge.
Retail Lease Accounting Practices and Embedded Leases
Retail industry accounting practices require careful evaluation of contracts that may not appear to be leases at first glance.
Service or supply contracts could also include embedded leases on property, plant, and equipment. For example, a retailer’s supply agreement may require a supplier to operate from a dedicated facility used exclusively for that retailer’s production or fulfillment needs.
According to the new standards that factory may need to appear on the retailer’s balance sheet as a leased asset. A retailer with a dedicated facility under contract as a third party to fulfill online orders might need to account for that facility as a leased asset under ASC 842.
Identifying embedded leases is especially important for retail organizations with complex vendor and logistics relationships.
Variable Lease Payments and Percentage Rent in Retail Leases
Variable rent structures are common in retail leasing arrangements and can materially affect lease accounting outcomes.
Many mall retail locations have lease contracts with terms that automatically change under certain circumstances. A monthly lease payment for a retail location might switch from a fixed amount to a percentage of sales if the mall loses an anchor tenant.
These variable lease payments must be evaluated carefully to determine which components are included in the lease liability and which are expensed as incurred. Retail tenants must also monitor these provisions over time, as changes in lease terms may trigger remeasurement or modification accounting.
Lease Modifications and Changing Retail Footprints
Retail businesses frequently modify leases due to store expansions, downsizing, relocations, or changes in market conditions.
Retailers must identify modified contracts, and then figure out how to include the modification on their balance sheets. Lease modifications may result in remeasurement of lease liabilities, adjustments to ROU assets, or reassessment of lease terms and discount rates.
Given the pace of change in the retail industry, lease modifications are often an ongoing accounting consideration rather than a one-time event.
Impairment Considerations for Retail Leases
Recognizing more lease assets on the balance sheet introduces additional impairment considerations for retail tenants.
Including more lease assets on the balance sheet could significantly increase the cash flows needed to recover those assets. Retailers must evaluate whether individual store locations or groups of stores remain economically viable, particularly in the case of underperforming or closing locations.
Retailers will need to understand how the ASC 842 lease accounting standard will affect their required impairment tests for individual store locations. This is especially relevant in environments where consumer demand, foot traffic, or store formats are changing rapidly.
Retail Lease Requirements Across Store, Wholesale, and Distribution Locations
Retail lease requirements vary depending on the type of location and its role within the organization.
The footprint of physical locations and leases for wholesale and distribution centers is typically much smaller than for retail businesses. While these locations are still subject to ASC 842, the volume and complexity of leases are often greater within the retail store portfolio itself.
Retailers must apply consistent accounting practices across all leased assets while recognizing that store leases often carry higher variability and operational risk.
Implementing Costar’s retail lease management software will assist with sorting out the difficult decisions necessary to ensure continued portfolio growth, and meet compliance standards at the same time.
