Service charges: principal or agent

Why are service charges not rental income?

A lease gives the tenant the right to use space. Cleaning the common areas, guarding the building and maintaining the lifts are separate services the tenant receives. IFRS 16 requires a landlord to separate these non-lease components from the lease and account for them under IFRS 15. The total consideration in the lease, rent and service charges together, is allocated between the lease and the services on a relative stand-alone selling price basis, although in practice the service charge usually approximates the stand-alone price of the services.

Service charges: is the landlord principal or agent?

The question is whether the landlord controls the services before they reach the tenant. Indicators that it does include that the landlord signs the contracts with cleaning, security and maintenance firms, decides who provides the services and how, and is the party the tenant can hold responsible under the lease if they are not delivered. Most commercial landlords managing their own buildings meet these indicators and are principals. A landlord is more likely to be an agent where the tenants appoint the managing agent, or where it simply passes on utility costs metered to each tenant at cost. See IFRS 15 principal vs agent.

Service charges: gross or net on a part-empty building

An office building's service costs for the year are CU 2,000 thousand. 10% of the space is vacant, so tenants are charged 1,800 thousand, and the landlord, as owner of the empty floors, bears the remaining 200 thousand.

Profit is the same; revenue is 1,800 thousand higher as principal. Either way, the cost of servicing empty space falls on the landlord, which is why vacancy hurts property returns twice: lost rent and unrecovered service costs. Many property companies show service charge income and costs separately and disclose the net unrecovered amount, a figure analysts track.

What about recharged property taxes and insurance?

Property taxes and the landlord's building insurance do not transfer a good or service to the tenant: they are costs of owning the property. Amounts the tenant pays for them are not a separate component. They form part of the total consideration in the contract and are allocated between the lease and any services, so most of the recovery ends up in rental income. Where the tenant pays the tax authority directly and the landlord has no obligation for the tax, the landlord records nothing.

How are budgets and balancing charges handled?

Service charges are usually billed quarterly in advance on a budget, with a balancing charge or credit once the year's actual costs are known. Revenue is recognised as the services are delivered, over time. Amounts billed before the services are provided are a contract liability. The expected balancing charge or refund is variable consideration: the landlord estimates it at each reporting date and adjusts revenue, recognising a refund liability where it expects to repay tenants. See variable consideration.

What about sinking funds and reserve funds?

Some leases require tenants to contribute to a fund for future major works, such as replacing a roof. In several jurisdictions, residential service charge money is held on trust for the tenants by law. Contributions held on trust are not the landlord's assets or revenue. Where the landlord keeps the money and has an obligation to spend it on the works or return it, it is a liability until the works are done.

How does US GAAP compare?

ASC 842 gives lessors a practical expedient to combine common area maintenance and similar services with the lease when they share the same timing and pattern of transfer and the lease is an operating lease, so many US landlords report these recoveries as variable lease income rather than as separate service revenue. Property taxes and insurance paid directly by the tenant to third parties are excluded from the landlord's revenue and costs. See IFRS 16 vs ASC 842 and real estate accounting.

This guide is general information. It is not tax or legal advice for your situation.