Capitalization of Legal Expenses Relating to Leases

Capitalization of legal expenses relating to leases

We are currently in court arguing a lease with a landlord. I do not know the specifics of the case but I am told we will most likely win. My boss wants to capitalize the legal expenses incurred to secure this lease because the amount has become very substantial. We are a retailer and all of our leases are classified as operating. The legal expenses were incurred in 2010 and we want to be able to match revenue and expenses. Obviously we do not have any revenues right now.

As we approached our 2010 year end audit, would we be able to capitalize these costs based on the expectations that we will win the case? Is this considered goodwill and therefore may not be capitalized because it is internally created? Or can these costs be considered costs to acquire an asset and be capitalized?

Thanks in advance.

Answers

Mark Stokes CFO • January 23, 2011

Good luck with that one! I must say this sounds a lot like an executive trying to make the books work for his own purposes and not those of the investors. Capitalizing legal expenses into a line where legal expenses never play a part sounds like a very slippery slope. Also, the threshhold of whether you expect something to happen or not is a very important thing to have your head around.

I am not your CPA and you should definitely reach out to them for guidance here! For my part, I would not use this treatment. This sounds like legal expense just like it would be legal expense if an employee sued the company. You wouldn't shuffle that cost into their salary line, now would you!? I would accrue this as a line-item under legal and if we win the case and have legal expenses covered for us or whatever, then I would credit it or put it to the proper account.

However, I see you are a staff accountant and not the CFO or Controller (and maybe your company doesn't have either position). I would be very careful about "okaying" something like this and would strongly encourage you to talk to someone senior to you in the finance/acct'g organization if such a person exists, and further I would encourage you or your boss to reach out to your audit/advisory firm's technical accounting leader to get their take on this. Don't be the fall guy for some wishful thinking from your boss! Just my $.02, of course.

Stephen Turk Principal • January 23, 2011

Well, it's clearly not goodwill.
GAAP tends to favor expensing costs as incurred. There are some limited situations when costs can be deferred or capitalized as part of the cost of an asset, although your situation is not one that is specifically discussed in the GAAP literature so you would have to analogize to other guidance.
I would start by asking what are the expected future benefits of these legal expenses? Can you demonstrate that the lease, if you are successful, will be on favorable (below market) terms? If not, it would not appear that you would even have a basis for a discussion regarding deferring the legal expenses.

Barrett Peterson Senior Manager, Actg Stnds & Analysis • November 6, 2011

The litigation costs are expenses as they are a dispute resolution item. The possibility of winning is a contingent gain, not allowed to be reflected under GAAP [only certain contingent losses are allowed]. I think expensing is your only allowable option. Help advise your boss that in accounting, outlays ate expensed as the universal "default" unless they meet a given item allowed as meeting the definition of an asset [contingent gains expressly excluded].

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Capitalization of Legal Expenses Relating to Leases

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