As coworking, hybrid working and return-to-office mandates continue to impact the post-pandemic work landscape, it’s no surprise that flexible office arrangements can offer strategic advantages.
Companies use flex space to meet the demands of constantly changing business requirements.
That's good news. But a question I often get asked is, “When do flexible office arrangements need to be presented on the balance sheet with lease assets and liabilities?”
Before I answer that, let’s define what, exactly, a flexible office arrangement actually is.
Define flexible office arrangement
A flexible office arrangement is sometimes called a flexible workspace, flex office, or flex space. The company WeWork (WeWork | Office Space and Workspace Solutions) did much to popularize the concept.
These arrangements usually take the form of a contract that enables companies to provide employees with options regarding where and how they work. The arrangements vary greatly because they are, well, flexible. One flexible office arrangement might involve space for one person on a day-to-day basis in different cities around the world, but another might involve multi-year use of an entire floor of an office building.
“Flexible office space (flex) may be one thread that will help us weave the tapestry of what work will look like in the future,” said real estate experts at CBRE.
I’ll add that it is important for real estate and accounting professionals to know how flex space will show up on company financial statements as well. The key factor to consider is whether or not a flexible office arrangement is a lease.
How flexible office arrangements relate to embedded leases
Lease accounting rules changed for US based public companies in 2019. That was before the COVID pandemic forever changed how we think about work location. While flexible office arrangements did exist in 2019, the use was a fraction of what it is today, and many companies did not consider them as a part of their initial lease accounting (ASC 842 or IFRS 16) compliance exercise.
Most companies did, however, consider the concept of embedded leases. Embedded leases are leases contained or hidden within larger arrangements; many times, labeled as service contracts. These service contracts may be for janitorial services, IT hosting services, and many other examples. To see a more exhaustive list, please see the 2025 Lease Accounting Guide.
The key accounting concept regarding embedded leases is substance vs. form. No matter what the contract says at the top of page one, if the agreement meets the definition of a lease, it is a lease. Even if only part of the contract relates to obtaining the use of a leased asset, that part of the contract should be accounted for as a lease.
Companies should be periodically examining contracts to make sure that embedded leases are accounted for properly. Those that don’t check run the risk of their auditors checking for them, which has resulted in more than a few audit corrections.
Flexible office arrangements, just like embedded leases, are often misunderstood. I mean, it’s called an arrangement, so it can’t be a lease, right? Remember, substance over form. If it meets the definition of a lease, we need to apply lease accounting rules.
Should flexible office arrangement be presented on the balance sheet?
The main impact of ASC 842 and IFRS 16 was putting most leases on the balance sheet with a right of use asset and lease liability. So, it makes sense that the most common accounting question regarding flexible office arrangements is regarding balance sheet treatment. Does flex space belong on the balance sheet or not?
It depends.
The answers to the following questions will determine if a flexible office arrangement needs to be on the balance sheet:
For accounting, a lease is a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. So, regardless of if a document says lease, contract, arrangement, agreement, or something else at the top, it is a lease if it has these five components:
When those five components are present, lease accounting rules need to be applied, and a right of use asset and lease liability may need to be added to the balance sheet. However, there are some opportunities to exclude a lease from balance sheet treatment.
If a lease is determined to be immaterial to the financial statements, a company can decide not to reflect an asset and liability on the balance sheet. IFRS 16 specifically sets the materiality threshold at $5,000, but ASC 842 says that companies can set a reasonable threshold perhaps similar to their existing fixed asset capitalization threshold. With the flexibility offered by FASB under ASC 842, some companies may be able to consider flexible office arrangements as immaterial. Under IFRS 16, it is hard to imagine that any office space lease would be immaterial based on a $5,000 threshold, unless it was for a very short time, in which case it would be excluded under the short-term exemption discussed next.
If a lease is for a total term of one year or less, both IFRS 16 and ASC 842 allow a company to exclude that lease from balance sheet treatment. However, options that are reasonably certain to be exercised are counted in the lease term. Auditors will look at the company’s historic practices regarding renewing office leases when examining reasonably certain option assumptions, so companies who use the short-term exemption should document carefully.
If lease payments are entirely variable, companies do not need to set up lease assets and liabilities. However, accountants should make sure that a variable payment is not an in-substance fixed payment. For example, if a variable payment for the amount of time a company uses office space includes a minimum charge per month, that minimum charge is the in-substance fixed payment and would be subject to balance sheet recognition if all the other criteria mentioned above are met.
Note that all the above scenarios will involve expenses reflected on the income statement regardless of balance sheet treatment.
Substance vs. form is important to consider when deciding if a flexible office arrangement is a lease and if it needs to be presented on the balance sheet. This is similar to the legal concept of the spirit of the law vs. the letter of the law. Accountants should use professional judgement when evaluating flex space agreements. A good question to consider is “would a reasonable person conclude that this agreement is a lease, that is longer than 12 months, that is material, and that includes fixed payments?” If so, it should probably be on the balance sheet.