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Rent Expense Question
09-24-2006, 08:34 AM,
#1
Rent Expense Question
Background
PAB Industries, a public company with a December 31 year-end, is a wholesaler of office supplies. The Company is headquartered in Lubbock (“Head Office”), but has four regional sales offices and warehouses (Northeast, Southeast, central and West). PAB has entered into operating leases for its office space and warehouses, with varying terms; certain of the leases include free/holiday rent periods, leasehold improvement allowances and/or scheduled rent increases. Davidson, Needles 7Fess (“DNF”) has audited PUB for three years. As a result of the findings outlined in the SEC’s Letter to the center for Public Audit Firms re Certain Lease Issues (concerning numerous instances of incorrect lease accounting and the failure of auditors to detect them), PAB has asked DNF to review the Company’s lease agreements, including significant terms, monthly rent, future minimum lease payments, and any associated leasehold improvements. DNF has set overall materiality at the financial statement level at $100,000. The 10-year average CPI is 1.0237.
Summary of Lease Arrangements by Region
Northeast – The Northeast office has an operating lease for its warehouse space in Boston, MA. This lease was entered into on February 27, 2004 and has a commencement date of March 1, 2004. At the time of signing, The Company negotiated a deal in which it would not have to pay rent for the first two months from lease commencement date. The annual rent is $1,850,000 (or $154,167 per month). The lease term is for a period of 72 months with the option to renew for an additional period of 72 months at the option of the landlord. The Company spent $2,000,000 in leasehold improvements at the lease’s inception. Accumulated depreciation on the leasehold improvements at 12/31/06 is $472,222.
Southeast- The Southeast region entered into an operating lease for office space in Atlanta, GA. The lease commencement date was July 1, 2006 for a period of 60 months with no renewal option. The company felt that this lease was favorable due to expected expansion of this region and the probability it would need to move larger promises in five years. Under this agreement, the landlord offered to reimburse the Company for lease improvement at 12$ per sq. ft. (floor space leased is 100,838 sq.ft.). The monthly rental for office space is 202,050.80$ with an annual increase of 10% per annum. At inception, the Company incurred $1,250,000 for leasehold improvements. The improvements have an expected useful life of four years. At 12/31/06 accumulated depreciation on these improvements was 125,000$. For the landlord’s incentive received by the Southeast region, the Company recorded the following journal entries in July 2006

Leasehold Improvements 1,250,000
Cash 1,250,000$
(Cost incurred to make changes to the Company’s premises.)
Cash 1,210,056
Leasehold Improvements 1,210,056
(Receipt of funds form the Landlord on July 30, 2006.)
Central- this office in Denver was established as a central point of distribution. The Company entered into the warehouse lease for 5,000$ per month for 48 months with the option to renew the lease. The annual increase in rent is 20%. The lease commencement date was October 1, 2003.
West- The Company entered into lease agreement for a warehouse in Seattle, WA on August 1, 2005. The monthly rent for the warehouse is 15,000$ per month and the term of the lease is 36 month with an option to renew for two years. There is no escalation clause in the lease agreement.
Head Office The final lease agreement relates to an office lease in Lubbock for head office operations. The agreement has been in place since Novemeber 1, 2001. The monthly rents is 22,000$ per month. The original lease term is for 60 months with the option to renew for an additional two years. Annual rent increases each year are based on change in the CPI.



Disclosures in the Financial Statement

Northeast Southeast Central West Head Office
2004
2005
2006
2007
2008
2009
2010
2011

Requirements

Complete the table above, providing the rent expense that should recognized for each region in the years listed. Provide supporting calculations.
Also address any additional non-rent measurement issues, including any corrections that should be made.
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