Billing and paying rent are a crucial part of lease management, yet frequently the invoiced amounts do not match up with the lease contract values. These variances, up until recently, flew under the radar for many landlords and tenants. However, with the advent of a new accounting standard IFRS/AASB-16, all leases over 3 years must now be put on a Lessee companies’ balance sheet.
IFRS/AASB-16 meant that the contractual values of the lease and the amount invoiced by the lessor must be reconciled frequently. Millions of rental invoices are created monthly and a significant percentage do not tie back to the lease correctly. Variances are difficult to detect especially when dealing with a large lease portfolio. Small variances can accumulate over time and become a sizable problem.
Variances between contractual and invoice amounts are a common occurrence and can happen for a number of reasons:
The largest culprit is inaccurate CPI calculations; this can be as a result of the lessee or lessor’s miscalculation. CPI adjustments are calculated using the index from the previous quarter of a CPI review over the corresponding quarter in the prior year and can be found on the Australian Bureau of Statistics or if you are a subscriber to My Portfolio, our lease management system, you have access to the Public CPI Table within the system.
Checking CPI calculations is crucial in avoiding variations between contractual and invoice values. Your lease may require different CPI adjustment methods e.g. Average of the eight Capital Cities Index or All Groups in each State Index.
These CPI differences are why it is critical to always refer back to the lease.
Missing a market rent review or fixed rent increase can also result in variations. It sounds simple but when you are dealing with lots of leases it is very easy to miss these key dates.
Rent Increases Calculated Incorrectly
Lastly, rent reviews can be recorded incorrectly resulting in rent reviews/ increases occurring too early, too late, or sometimes not at all. Incorrect review dates can compound variations over many years and may only become apparent many years later or at the end of a lease, when conducting an audit.
Commencement and rent Increase dates that start mid-way through a month create significant challenges. These are referred to as broken period adjustments.
All these facets are simple, however, when applied over a large lease portfolio can become difficult to find and compound into large unaccounted for variances.
To demonstrate how easily variances can occur let us look at the following example:
Your lease starts with a base rent of $120,000, commences on the 15th of January 2010 and expires on the 31st of December 2017. Rent increases occur on the 15th of January each year and use the formula CPI + 2.5%, ALL Groups NSW, with a market rent review on the 4th year.
This lease agreement contains many pitfalls and traps which can lead to variances if not managed correctly. Firstly, the lease commences in the middle of the month, resulting in a broken period. Broken periods can be accounted for in two different ways, which are stipulated in the lease; Either the remaining number of days in that month will be paid for as a percentage of the monthly rent or the remaining days of the month will be paid for as a percentage of yearly rent.
If we were to calculate for monthly rent, the lease commences on the 15th of January so there are 17 days left in the month of January and if the base rent is $120,000 then monthly rent will be $10,000.
($10,000 / 31) x 17 = $5,483.87.
Therefore, if the lease stipulated the broken period is to be paid as a percentage of monthly rent, in our example you would pay $5,483.87 for January 2010.
However, if the broken period is to be paid as a percentage of yearly rent, the calculation would be as follows:
($120,000 / 365) x 17 = $5,582.92
You would be paying an extra $105 which can impact balance sheet figures and create variances which are difficult to account for without a lease management system in place. Moreover, the broken period calculation would need to be done every year, as there is a broken period review on 15th of January each year.
CPI is another area where variances can occur. Looking at our example lease, rent reviews are calculated using the formula CPI + 2.5%. A common mistake for these types of calculations is using the wrong type of CPI.
In Australia alone there are 9 different CPI’s that are updated quarterly so it is imperative that you always refer to the lease. Moreover, when calculating CPI you must use the CPI figures from the previous quarter of the review date divided by the corresponding quarter in the previous year.
Let’s say, using our example, you are calculating your rent for January 2011. Your lease states that you are to use CPI Sydney when calculating CPI.
This means that you would use the December 2010 Quarter CPI Sydney divided by the December 20009 Quarter CPI Sydney.
At the time CPI Sydney for the calculation was 2.99% so you would do the calculation:
$120,000 + (120,000 x (2.99% + 2.5%)) = $126,588 (Rent increase = $6,588)
However, if, by mistake you were to use Average All State CPI instead of Sydney, which was 3.2% your calculation would look like this:
$120,000 + (120,000 x (3.2% + 2.5%)) = $126,840 (Rent increase = $6,840)
Which is almost a $300 difference to the correct rent increase.
Or say you were to use the CPI from the March 2011 quarter, which at the time was 3.15%, your calculations would be different again.
This example shows how important it is to always refer back to your lease. It could save countless hours untangling unaccounted for variances and save you money in ensuring you are paying the correct contractual amount
Managing Your Leases
However, if you are still having trouble, as many of our clients have had in the past, managing your IFRS/AASB-16 reporting and accounting for variances, you may want to look into a lease management software or invoice checking system.
Variance can occur for a number of different reasons including incorrect CPI calculations, missing a rent review or simply as a result of basic human error. If these variances are not accounted for then they can compound over time resulting in large differences that can only be detected during an audit. Using and invoice checking software can instantly identify changes and ensure that the assets on your balance sheet are capitalised correctly.
This post was authored by Simon Fonteyn. Simon is one of Australia’s leading experts in retail, childcare and medical leasing and rental valuations. He holds a Degree in Accounting & Finance, a Diploma of Valuation, a Masters of Management and is an Associate of the Australian Property Institute. With over 25 years experience in the commercial property industry, Simon founded LeaseInfo® as a way to provide more transparency to the industry.