Breaking Down Restaurant Lease Accounting

In the past, restaurant lease accounting was relatively straightforward. Most leases were treated as operating expenses, appearing only on the income statement. However, with the introduction of new accounting standards like ASC 842 (in the U.S.) and IFRS 16 (internationally), lease management requires the help of financial experts like Paperchase to fully understand and manage compliance.

These regulations have fundamentally shifted how leases are recorded on financial statements, bringing them onto the balance sheet and requiring a new level of detail and expertise. This change affects every business with significant real estate commitments, including restaurants, bars, hotels, and nightclubs.

This guide will break down what restaurant lease accounting is, how these new rules impact your financial reports, and why a hospitality accountant or specialized restaurant accountant is essential for staying compliant and gaining true financial clarity.

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1. What Is Restaurant Lease Accounting?

At its core, lease accounting is the process of tracking and reporting a company’s lease agreements on its financial statements. For a restaurant, this includes accounting for the initial lease agreement, any renewal options, deferred rent, and charges like Common Area Maintenance (CAM) or percentage rent. Lease accounting ensures that these long-term commitments are accurately reflected in the company’s financial position.

The Importance of Lease Accounting in the Restaurant Industry

Real estate costs are a significant portion of a restaurant’s operating expenses. A typical lease can span 10 to 20 years, representing a substantial, long-term liability. Proper lease accounting is critical for:

• Financial Reporting Accuracy: It ensures that a company’s financial statements provide a complete and accurate picture of its obligations. This is crucial for attracting investors, securing loans, or selling the business.
• Compliance: Adherence to standards like ASC 842 is mandatory. Non-compliance can lead to audit failures, penalties, and a loss of credibility with stakeholders.
• Operational Insight: Accurate lease accounting helps a restaurant owner understand the true cost of their real estate, which is vital for effective budgeting, forecasting, and strategic decision-making.

Types of Leases Common in Hospitality

• Operating Leases: Before the new standards, most restaurant leases were considered operating leases. The monthly rent expense was simply recognized on the income statement, and the liability was not reported on the balance sheet. This often made companies appear to have less debt than they actually did.
• Finance Leases (or Capital Leases): These leases historically were treated as an asset purchase. The lessee would record the leased asset and a corresponding liability on the balance sheet, then recognize depreciation and interest expense over the lease term. This type of lease was less common in hospitality.

Now, under ASC 842, the distinction is still relevant but no longer determines whether a lease appears on the balance sheet. All but the shortest-term leases are now recognized on the balance sheet.

2. Impact of Lease Accounting Standards on Hospitality Businesses

The biggest change came from FASB ASC 842 and IFRS 16, which were designed to increase transparency by requiring companies to report most leases on their balance sheets. For hospitality businesses, which often have multiple, long-term leases for their properties, this has a significant impact on financial reporting.

Changes from Traditional to Current Lease Reporting Rules

Under the old rules, a typical restaurant lease didn’t show up on the balance sheet. A potential lender or investor would have to read the footnotes of the financial statements to find information on future lease payments.

With the implementation of ASC 842, this changed. Now, a restaurant must recognize a “right-of-use” (ROU) asset and a corresponding lease liability on its balance sheet for nearly all leases with a term of more than 12 months.

Why Restaurants, Hotels, and Nightclubs Must Report Leases on the Balance Sheet

This new reporting requirement addresses the issue of “off-balance-sheet financing.” Lenders and investors need to understand the full scope of a company’s obligations. By placing the lease liability on the balance sheet, the new standards provide a more accurate picture of a restaurant’s financial health and leverage.

This can impact key financial ratios, such as the debt-to-equity ratio, which are often used by banks to determine a company’s creditworthiness. While it doesn’t change the underlying economics of the business, it does change how it’s presented.

3. How Restaurant Lease Accounting Works (Step-by-Step)

The process of lease accounting for restaurants, while complex, can be broken down into a few key steps.

Lease Identification and Classification

First, a restaurant’s restaurant accountant must identify all lease agreements, including embedded leases (e.g., equipment leases within a broader service contract). Each lease is then classified as either an operating or finance lease. The classification determines how the expense is recognized on the income statement, though both will now be on the balance sheet.

Calculating Right-of-Use Asset and Lease Liability

The next step is to calculate the ROU asset and the lease liability. This is not a simple calculation. The lease liability is the present value of all future lease payments, discounted using the lease’s implicit interest rate or, if that’s not available, the restaurant’s incremental borrowing rate. The ROU asset is then calculated based on the lease liability, plus any initial direct costs (like legal fees) and minus any lease incentives received.

Recording Journal Entries Monthly

On a monthly basis, a restaurant accountant must record a series of journal entries. This includes:

• Payment Entry: Debit Lease Liability and Credit Cash for the monthly payment.
• Interest Expense Entry: Debit Interest Expense and Credit Lease Liability to recognize the portion of the payment that represents interest.
• Amortization Entry: Debit Amortization Expense and Credit the Right-of-Use Asset.

Amortization, Interest, and Expense Recognition

For an operating lease, the monthly expense is recognized on a straight-line basis. The amount of interest and amortization expense will vary each month, but the net effect is a consistent, straight-line total expense that is easier to manage and budget. For a finance lease, interest and amortization are recognized separately, leading to a front-loaded expense curve.

Tracking Modifications, Renewals, and Terminations

Leases are dynamic. A restaurant may negotiate a rent reduction, extend a lease term, or even terminate an agreement early. Each of these changes requires a re-measurement of the ROU asset and lease liability, which can be complex and requires careful tracking.

4. Why You Need a Hospitality Accountant or Restaurant Accounting Partner

Given the complexity of ASC 842 and IFRS 16, it’s clear that lease accounting is no longer a task for generic bookkeeping tools or an in-house team with limited accounting knowledge. A specialized hospitality accountant or a firm that offers hospitality accounting solutions is essential for navigating these new rules.

How Hospitality Accountants Simplify Lease Accounting

• Expert Knowledge: A professional restaurant accountant understands the nuances of the new standards and how they apply specifically to the hospitality industry, including the complexities of percentage rent and CAM charges.
• Accurate Calculations: They can accurately calculate the ROU asset and lease liability using the correct discount rates and present value formulas.
• Compliance and Audit Readiness: They ensure all required journal entries and disclosures are prepared correctly, reducing the risk of an audit finding.

Paperchase works closely with Occupier, a lease accounting software that empowers restaurateurs and franchisees to seamlessly manage their day-to-day real estate operations and technical lease accounting requirements. Occupier crafts lease management and accounting workflows that automate daily processes. Learn more about how Paperchase’s tech and finance partners can help your business here. 

Why Restaurant Accountants Are Essential for Multi-Unit Operators and Franchisees

For businesses with multiple locations, lease accounting becomes exponentially more complicated. Managing dozens or even hundreds of leases requires a specialized accounting partner that can use cloud tools and standardized processes to manage this at scale, ensuring consistency and accuracy across the entire portfolio.

5. Common Mistakes in Restaurant Lease Accounting & How to Avoid Them

Misclassifying Leases or Omitting Embedded Leases

A common mistake is failing to identify all leases. A service agreement for a coffee machine, for example, might be an embedded lease that needs to be accounted for. Failing to do so can lead to an incomplete and inaccurate balance sheet.

Failing to Track Lease Modifications

When a lease is modified, even for something as simple as an abatement or a rent deferral, the ROU asset and lease liability must be re-measured. Neglecting this step can lead to significant discrepancies.

Inaccurate Amortization Schedules

Creating and maintaining accurate amortization schedules for each lease is crucial. Errors in the initial calculation or in the monthly entries can compound over time, leading to major reporting issues.

Checklist: Lease Accounting Do’s and Don’ts for Restaurants and Hotels

• Do identify all lease agreements, including embedded leases.
• Do work with a hospitality accountant who understands ASC 842.
• Do use a lease accounting software or a cloud-based solution to track your leases.
• Don’t rely on a simple spreadsheet for tracking your leases.
• Don’t forget to re-measure assets and liabilities when a lease is modified.
• Don’t ignore the need for expert financial guidance.

NYC Hospitality Alliance: Industry Statistics

Conclusion

Getting restaurant lease accounting right is essential for compliance, transparency, and effective financial management. The shift in accounting standards means that leases are now a central part of a restaurant’s financial health, requiring a level of detail and expertise that most operators don’t have in-house.

Operators must audit their current lease reporting methods and ensure they have updated their systems to comply with ASC 842 and IFRS 16. The best way to do this is to partner with a specialized restaurant accountant or a firm that provides dedicated hospitality accounting solutions. This will not only ensure accuracy and reduce audit risk but also provide a clearer, more insightful view of your business’s financial future.

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