Commercial lease expense verification: what CPAs miss
CPAs working with commercial real estate tenants are familiar with ASC 842. Recognizing right-of-use assets, calculating lease liabilities, distinguishing finance leases from operating leases: these are standard territory. But ASC 842 compliance and CAM expense verification are not the same activity.
Here's what most CPAs who work with NNN lease clients don't realize: ASC 842 tells you how to record what you pay. CAM audit tells you whether what you're paying is correct. The two activities require different reference documents and different analytical frameworks.
This article covers the specific gaps in a standard CPA review of commercial lease operating expenses, and what a more complete verification process looks like.
ASC 842 vs. CAM audit: ASC 842 (FASB Accounting Standards Update 2016-02) governs how lessees recognize lease obligations on the balance sheet, treating operating leases with right-of-use assets and liabilities. A CAM audit, by contrast, is a tenant-side verification that the landlord's annual operating expense reconciliation complies with the specific terms of the lease. ASC 842 compliance does not verify whether the landlord's charges are correct.
The ASC 842 compliance gap
When a tenant complies with ASC 842, they recognize a lease liability and right-of-use (ROU) asset based on future minimum lease payments. Variable lease costs, including CAM and operating expense pass-throughs, are expensed as incurred rather than included in the ROU asset calculation in most NNN lease structures.
This treatment is appropriate under GAAP. But it means that the accuracy of the variable lease cost recognized depends entirely on whether the landlord's invoicing and reconciliation is correct. ASC 842 does not include a verification step. It assumes the variable costs received from the landlord are accurate.
If the landlord's management fee calculation exceeds the lease cap, that excess flows through the financials as a legitimate expense under ASC 842. The lease liability is calculated correctly. The expense recognition is technically correct under GAAP. But the underlying charge is wrong under the lease terms, and the client is overpaying.
The gap is not an accounting gap. It is a lease compliance verification gap.
Gross-up provisions: the most commonly missed CAM clause
Gross-up provisions appear in most commercial leases but are rarely reviewed in a standard CPA engagement. Here's how they work and why they matter.
In a multi-tenant building with significant vacancy, the fixed operating expenses (management, utilities for common areas, insurance) are spread across fewer paying tenants. If the building is 60% occupied, tenants at 60% occupancy absorb costs that were designed to be shared across a 90-95% occupied building.
The gross-up provision addresses this by allowing the landlord to calculate CAM as if the building were at a specified occupancy level (typically 90-95%), even if actual occupancy is lower. This prevents tenants from being overburdened by vacancy-driven cost increases.
What CPAs typically review: whether the gross-up amount is included in the variable lease cost calculation for ASC 842 purposes (it generally is).
What CPAs typically miss: whether the gross-up calculation was applied correctly given the actual occupancy levels, whether the gross-up percentage specified in the lease was used, and whether the gross-up was applied to the correct subset of expenses (gross-up typically applies only to variable operating expenses, not to fixed expenses like property taxes).
A gross-up calculation error can increase or decrease the tenant's billed amount by a significant percentage. If the building was at 70% occupancy and the landlord grossed up to 100% instead of the lease-specified 90%, the tenant's share of variable expenses is overstated.
More on that below when we look at how to verify the gross-up.
Capital expense misclassification: a GAAP problem and a lease problem
CPAs are well-trained to distinguish between capital expenses and operating expenses under GAAP: items with a useful life beyond one year and above the client's capitalization threshold go on the balance sheet. Items below go to expense.
The CAM audit version of this analysis is different. Under most commercial leases, certain items are defined as capital improvements and must either be excluded from CAM or amortized over the item's useful life, regardless of how the landlord accounts for them under their own GAAP policies.
A $200,000 parking lot reseal has a useful life of 7-10 years. Under GAAP, the landlord capitalizes it (or expenses it depending on their own policy). Under a typical NNN lease with standard capital improvement provisions, the tenant's share must be amortized over the useful life, not expensed in the year incurred.
The CPA reviewing the tenant's financials sees the variable lease cost line item and applies ASC 842 treatment. The capital versus operating distinction applied by the CPA is the client's own capitalization policy. The CAM audit version asks: does the landlord's treatment of this item in the reconciliation comply with the lease's definition of capital improvements?
These are two different analytical questions. A standard financial statement review answers the first. Only a lease-level review answers the second.
Base year errors: the accounting review isn't enough
Base year leases (also called expense stop leases) are common in office buildings. In a base year structure, the tenant pays the full cost of operating expenses in the base year (typically the first lease year), and in subsequent years pays only the amount by which operating expenses exceed the base year amount.
CPAs are generally aware of base year provisions and incorporate them into lease accounting. But what standard accounting reviews often miss is whether the base year amount itself was calculated correctly.
Base year errors occur when:
The base year expenses were understated. A landlord who depresses the base year expenses (by deferring maintenance, delaying capital work, or excluding certain expenses from the base year calculation) creates a lower floor, which means the tenant will exceed the base year and pay overages sooner and in larger amounts.
The wrong year's expenses were used. The lease specifies the base year. If the landlord applies a different year's expense level, or if the base year was later renegotiated without a formal amendment, the calculation may be off.
The expense categories in the base year don't match the categories being billed in subsequent years. If certain expense categories were excluded from the base year calculation but are included in the current year reconciliation, the comparative calculation is apples to oranges.
A base year error is not visible from the financial statements. It requires comparing the current year reconciliation to the base year schedule in the lease, which requires having both documents and knowing what to look for.
"The accounting is usually right. The lease compliance is where CPAs find gaps. ASC 842 records the payment. CAMAudit verifies whether the payment should have been that amount in the first place." — Angel Campa, Founder of CAMAudit
What a complete commercial lease expense verification looks like
A complete verification combines the financial accounting review (already part of most CPA engagements) with a lease compliance review (often missing). The lease compliance review adds:
Management fee cap verification. Compare the total of all management and administrative fees in the reconciliation to the lease cap.
Pro-rata share verification. Confirm the denominator used matches the lease's definition. Request the rent roll.
Gross-up provision review. If applicable, verify the gross-up percentage and the expense categories to which it was applied.
Capital expense classification. For large line items, determine whether they should be amortized under the lease rather than expensed.
Base year reconciliation. For expense stop leases, confirm the base year figure is consistent with the lease and that the comparison is made on a like-for-like basis.
Excluded service verification. Confirm that items on the lease's exclusion list do not appear in the reconciliation.
CAMAudit processes the reconciliation against the lease and flags potential violations in each of these categories automatically. Refer clients with NNN lease exposure to CAMAudit at CAMAudit for a free scan before paying the annual true-up.
Questions CPAs ask about commercial lease expense verification
Frequently Asked Questions
Does ASC 842 require me to verify CAM reconciliation accuracy?
ASC 842 governs recognition and measurement of lease obligations. It does not require the lessee to verify whether variable lease costs billed by the landlord comply with the lease terms. That verification is a separate contractual responsibility of the tenant.
What is a gross-up provision and how do I verify it?
A gross-up provision allows the landlord to calculate variable CAM as if the building were at a specified occupancy level. To verify it: confirm the lease-specified occupancy percentage, confirm the actual occupancy for the period, and verify that only variable expenses were grossed up, not fixed expenses like property taxes.
How do I identify a base year error in a commercial lease?
Request the base year expense schedule from the lease or from the landlord. Compare expense categories to the current year reconciliation. Verify that the base year figure represents actual expenses from the specified year and was not artificially suppressed.
Can I use CAMAudit as part of my client service workflow?
Yes. CAMAudit processes reconciliation statements and flags potential overcharges based on lease terms. It is most useful after your standard financial review identifies potential issues, as the tool provides the lease-level verification that goes beyond what accounting review covers.
What is the difference between expense stop leases and NNN leases for CAM audit purposes?
In a NNN lease, the tenant pays operating expenses directly as a pass-through. In an expense stop (base year) lease, the tenant pays only the amount by which expenses exceed the base year. Both structures can have billing errors, but the base year error is unique to expense stop leases.
Sources
- FASB. ASC 842 Leases guidance and implementation resources. https://www.fasb.org/
- AICPA. Commercial real estate accounting and lease audit resources. https://www.aicpa.org/
- IREM (Institute of Real Estate Management). Operating expense reconciliation resources. https://www.irem.org/
- Tango Analytics. "CAM Reconciliation: Why tenants should verify the math." https://tangoanalytics.com/blog/cam-reconciliation/
Refer commercial tenant clients to CAMAudit for a free scan. The tool covers the lease compliance verification layer that standard CPA review doesn't reach.