How Does Build to Suit Accounting Work?

A build-to-suit lease is an arrangement where a company, the lessee, contracts with a developer, the lessor, to construct a property to the lessee’s specifications. These agreements are common for businesses with unique operational needs, like manufacturing plants or distribution centers. The accounting for these leases is governed by the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 842. This standard requires an analysis to determine who controls the asset during construction, which dictates the accounting path.

Determining Lessee Control During Construction

The primary step in accounting for a build-to-suit lease is determining if the lessee controls the asset during construction. Under the guidance, this analysis focuses on control rather than risks and rewards. If the lessee has control, it is treated as the asset’s owner for accounting purposes. The guidance provides several indicators that establish lessee control, and the presence of any one is sufficient.

• The lessee has the right to obtain the partially constructed asset at any point during the construction period. For example, if the agreement includes a call option allowing the lessee to purchase the construction-in-progress from the lessor, this right demonstrates control.
• The asset is so specialized that the lessor has no alternative use for it and has an enforceable right to payment for work completed to date. An example is a laboratory with a unique layout and structural features designed for specific research, making it impractical for the lessor to lease to another tenant without significant losses.
• The lessee has legal ownership of the asset or controls the land on which it is being built. This control exists if a company owns a parcel of land and hires a developer to build on it for a leaseback, or if it holds a long-term ground lease covering substantially all of the building’s economic life.
• The lessee’s participation in the design process goes beyond providing standard specifications and essentially dictates the asset’s fundamental characteristics. Control is also implied if the lessee is responsible for arranging or guaranteeing the construction financing or guarantees the asset’s value to the lessor.

Accounting for the Lessee as the Asset Owner

When the analysis concludes the lessee controls the asset during construction, it is accounted for as the owner from the project’s inception. This process has two phases: the construction period and the lease commencement. During construction, the lessee must recognize the asset on its balance sheet by recording a Construction-in-Progress (CIP) asset. As the lessor incurs costs to build the property, the lessee increases the CIP asset’s value and records a corresponding financial liability, reflecting the obligation to the developer.

Upon completion, the lease officially commences. The arrangement is then evaluated under sale-leaseback guidance, but it results in a “failed sale-leaseback” because control never transfers from the lessee to the lessor. Consequently, the lessee continues to account for the property as a financed purchase. The CIP asset is reclassified to a permanent fixed asset, such as “Building,” and the lessee begins to depreciate it over its useful life. The financial liability is treated like a loan, with lease payments allocated between interest expense and principal reduction.

Accounting When the Lessee is Not the Asset Owner

If the lessee does not control the asset during the construction phase, no accounting entries are made while the property is being built. The project remains entirely on the lessor’s books. The lessee’s accounting responsibilities begin only on the lease commencement date, which is when the completed asset is made available for use. At this point, the arrangement is treated like any standard lease.

The lessee must first classify the lease as either an operating lease or a finance lease based on criteria that assess the transfer of ownership or value. Once classified, the lessee recognizes a right-of-use (ROU) asset and a lease liability on its balance sheet. The lease liability is calculated as the present value of future lease payments. The ROU asset is based on the liability, adjusted for any initial direct costs or lease payments made before commencement.

Financial Statement Presentation and Disclosures

The presentation of a build-to-suit lease on financial statements depends on the control assessment. The disclosures aim to help investors understand the cash flows arising from the lease. If the lessee is the asset owner, its balance sheet shows a fixed asset, such as “Property and Equipment,” and a long-term financial liability. If not the owner, the balance sheet reports a “Right-of-Use Asset” and a “Lease Liability.” This classification difference can affect financial ratios.

The income statement impact also differs. An owner-lessee recognizes depreciation expense on the asset and interest expense on the liability. For a non-owner, an operating lease results in a single, straight-line lease expense, while a finance lease has separate amortization and interest expenses.

Companies must also provide detailed footnote disclosures. These include a description of the arrangement, significant terms, and judgments made. For arrangements where the lessee is the owner, disclosures include the carrying amount of the asset and the related financing obligation. All leases require disclosures on lease costs, weighted-average lease terms, and discount rates.