Understanding the Financing and Accounting of Logistics Centers
When planning a large-scale project such as a logistics center, there are many factors to consider: structural aspects such as planning, building permits, and the question of the optimal location, as well as logistical aspects such as warehousing technology and order-picking systems. Added to these are fundamental issues such as financial viability, accounting matters, and tax considerations. However, even the form of financing, for example, has an impact on accounting and taxation. Given the wide range of options for financing, accounting, and taxation—and their interdependencies—this article can only address selected aspects and provide an initial overview.*
Financing
Decision-makers are well advised to consider the financing of a large-scale project early on. In general, the following forms of financing are options:
Self-financing
, Debt financing
, Lease
financing—Operating
lease, Financial lease
, Sale-and-lease-back financing
Self-financing: Self-financing can take the form of internal financing using retained earnings—such as through retained earnings reserves or non-cash expenses like depreciation—or external financing through the inflow of external equity, via shareholder contributions or capital increases.
Debt Financing: The project is financed with debt, typically through a bank loan—which incurs not only interest during the construction period but also long-term financing interest.
Operating Lease: In principle, the contractual relationship can be terminated at any time on short notice, as no minimum lease term has been agreed upon. In practice, however, cases where there is no minimum lease term are virtually nonexistent. What is more significant here are the so-called leasing directives issued by the tax authorities and, consequently, the definitions of terms set forth therein (see below). In the case of constructing a logistics center, however, this (operating lease) is hardly conceivable.
Financial Leasing: In principle, these are (disguised) lease agreements that are heavily intertwined with elements of a purchase agreement. Such contracts are concluded for a fixed minimum lease term, which precludes proper termination. According to the tax authorities’ so-called leasing guidelines—which are relevant for lease accounting—financial leasing also requires that the lessee’s payments during the basic lease term cover at least the acquisition and production costs as well as all ancillary costs, including the lessor’s financing costs.
A sale-and-lease-back is, in principle, a special case of lease financing in which the lessor acquires the leased asset not from a third party but from the lessee and then leases it back to the seller. In addition to these “pure forms” of financing, hybrid financing arrangements are frequently used in practice—for example, a combination of equity and debt financing. In addition, there are more specialized forms of financing, such as profit-sharing loans or silent partnerships. These are often grouped under the term “mezzanine capital”—and will not be discussed in further detail here.
Accounting Aspects
With regard to accounting, the German Commercial Code (HGB), German tax accounting law, and IFRS (International Financial Reporting Standards) each have their own, sometimes distinct, regulations. The following discussion focuses primarily on German balance sheet and tax balance sheet law, which, due to the so-called “relevance principle,” has a significant overlap with accounting standards.
Dr. Harald Riedel
Dr. Harald Riedel is a certified public accountant, tax advisor, and founding partner of PKF Riedel Appel Hornig GmbH, with more than 30 years of experience in auditing, tax consulting, and management consulting.
He specializes in auditing and advising manufacturing, retail, and service companies; designs tax models; performs business valuations; and advises on structural measures. Dr. Riedel is a member of the executive board of PKF Deutschland GmbH and a member of the Chamber of Tax Consultants and the Chamber of Public Accountants.
His practice focuses on:
- Restructuring/Conversions
- Acquisitions and divestitures
- Corporate tax law
- International tax law
- Contact person for small and medium-sized businesses
His key industry areas are:
- Automotive
- Fashion
- Service Companies
- Renewable Energy
Dr. Harald Riedel will be happy to assist you:
How is this accounted for?
It goes without saying that the construction costs of the logistics center must be capitalized and depreciated over its expected useful life. Capitalization as a building and the start of depreciation typically occur only upon completion of the entire structure.**
The land must be capitalized separately and is not subject to scheduled depreciation. With regard to the construction costs for the building, a clear distinction must be made in the financial statements between the portion of the construction costs attributable to the building and that attributable to operating equipment, which must be capitalized separately. This distinction between building components and operating facilities is significant, for example, for depreciation purposes (operating facilities are typically depreciated over a shorter useful life) the amount of the real estate transfer tax base (if the property were to be the subject of a transaction subject to real estate transfer tax in the future, such as a share deal subject to real estate transfer tax), and the tax-minimizing extended land deduction for trade tax purposes. With regard to distinguishing real property from business facilities, the state tax administration’s circulars provide a good initial point of reference.
How is depreciation calculated?
Under German commercial law, a component-based approach is permissible for depreciation purposes in cases where physically separable components that are material in relation to the entire tangible fixed asset are replaced (IDW HFA RH 1.016). The component approach refers to a method in which an asset is conceptually broken down into its essential components with different economic useful lives in order to determine the amount of the asset’s scheduled periodic depreciation as the sum of the scheduled depreciation for each component. As an example, the Institute of Public Auditors in Germany (IDW) cites the separate depreciation of the roof (useful life of 20 years) and the remainder of the building (useful life of 60 years) in the case of a building. Compared to determining the scheduled periodic depreciation for the entire asset based on its flat-rate total useful life, this component-by-component depreciation results in different depreciation amounts, and, as a result, leads to a more cause-based allocation of the expense arising from the use of the asset. In line with this component-based depreciation, expenditures for the replacement of such a separable component are not to be treated as maintenance expenses but are to be capitalized as subsequent acquisition or production costs. It should also be noted that the component approach itself does not affect the asset as a reporting unit. Only the method of scheduled depreciation is modified.
Under IFRS accounting as well, a component-based approach is applied in the context of scheduled depreciation in accordance with IAS 16.43 et seq.
In the tax balance sheet, however, component-by-component depreciation is not permitted. The principle does not apply due to the tax valuation reservation (Section 5(6) of the German Income Tax Act (EStG)). For business buildings, tax law generally assumes a uniform, standardized depreciation period of 33.33 years.
How are leases accounted for?
The key issue in lease accounting under German accounting law (both under the German Commercial Code (HGB) and tax law) is typically the question of to whom the leased asset is (economically) attributable: the lessor or the lessee. This determination governs the subsequent legal consequences, in particular, who is required to recognize the leased asset on its balance sheet. The so-called leasing directives issued by the tax authorities play a significant role in assessing lease accounting. Since a logistics center—which is yet to be built—is generally designed to be highly tailored to the needs of the (future) lessee, and since any other economically viable use or exploitation of the building is typically unlikely, this will usually constitute a special-purpose lease. The result: The leased asset—the logistics center—is attributable to the lessee as the economic owner, regardless of the base lease term or similar factors. Exceptions apply, however, in the case of land. Here, depending on the specific terms of the lease agreement (including the length of the base lease term in relation to the normal useful life of the property, the existence and terms of purchase or lease extension options)—it must be determined separately in each case, based on the Leasing Decree of March 21, 1972, whether the land is to be capitalized on the lessor’s or the lessee’s balance sheet.
If the lessee, as the economic owner, capitalizes the logistics center at its acquisition and production costs (The starting point for this is the lessor’s acquisition and production costs, which were used as the basis for calculating the lease payments), the lessee must recognize a corresponding liability to the lessor.
If the lease is not a special lease, the contractual terms must be reviewed to determine whether the logistics center should be attributed to the lessor or the lessee for accounting purposes. Important criteria for attributing the asset to the lessee include:
- The ratio of the base lease term to the normal useful life. The Lease Decree for Buildings specifies a period of 50 years as the standard normal useful life.
- Existence and terms of purchase options
- Existence and terms of lease extension options
If, as with a special lease, the leased asset is attributable to the lessee, the lease payments made by the lessee must be allocated into an interest component and a principal component, and the logistics center must be capitalized by the lessee.
Special case: sale-and-lease-back: If the contract is structured such that the lessee remains the economic owner—which is likely to be the rule in a sale-and-lease-back arrangement—the leased asset remains with the lessee throughout the term. There is no transfer of the leased asset to the lessor and back to the lessee for accounting purposes. The lease payments are treated as purely financing and recognized as other liabilities. The lease payments made must be allocated into principal and interest components.
Under IFRS, lease accounting is governed by IFRS 16. The distinction between operating and finance leases, which was previously required under IAS 17, no longer applies to the lessee at all. Nor does the question of asset recognition—which is significant under German accounting law—arise. At the beginning of the lease term, the lessee must capitalize the right-of-use asset and recognize the lease liability. The starting point for measuring and recognizing the right-of-use asset and the lease liability is the present value of the lease payments. With regard to the subsequent measurement of the lease liability, the current payments are split into an interest component and a principal component. The right-of-use asset is to be depreciated on a straight-line basis and (if necessary) through extraordinary depreciation, just like a “normal” property, plant, and equipment asset.
How does the form of financing affect the equity ratio?
From a financial statement perspective, the choice of an appropriate financing method must also take into account its impact on the equity ratio. This can play a significant role in certain cases, such as with financial covenants. Here is an example:
If the project is financed from retained earnings (self-financing in the form of internal financing), this has no impact on the equity ratio, since on the asset side of the balance sheet, funds are merely reallocated to property, plant, and equipment (logistics center)—a so-called asset swap.
If self-financing is achieved through an inflow of new funds from external sources—such as shareholder contributions or capital increases—this results in a strengthening of the equity ratio.
In contrast, financing through bank loans reduces the equity ratio, as equity is then offset by a proportionally higher amount of debt.
Since, under German accounting law—which assumes economic ownership lies with the lessee—as well as under IFRS 16, a liability to the lessor must be recognized on the balance sheet, the equity ratio also decreases when financing is provided through leasing.
As a general rule, the capital asset—in this case, our logistics center—is likely to be reported on the balance sheet of the operating company. In practice, it is not uncommon for alternative arrangements to be used, whereby the capital asset is spun off into special purpose vehicles (SPVs). One of the purposes of this is that these entities are structured in such a way that they do not have to be included in consolidated financial statements and thus do not affect the consolidated equity ratio.
Tax Considerations
For reasons of complexity, the following tax considerations are limited solely to income tax issues.
From an income tax perspective, most key decisions are already made at the time the financing method is selected—and, as a result, this also determines the (tax) accounting treatment, such as the distinction between building components and operating facilities, the capitalization of interest during construction (see below), the accrual of lease payments or depreciation and financing interest.
The capitalized costs of the capital asset generally result in a tax-reducing effect only through annual scheduled depreciation. While land (and thus also incidental acquisition costs such as real estate transfer tax) cannot be depreciated on a scheduled basis at all, the tax depreciation of a building is generally spread over a period of 33.33 years. Only capitalized operating equipment can generally be depreciated for tax purposes over a shorter period. If the asset is accounted for by the financing provider (for example, in the case of a lease, by the lessor), the lease payments may generally be deducted from the income tax base as immediately deductible business expenses (see below for special provisions regarding trade tax).
Financing interest generally reduces the tax base and thus the tax burden, unless, in exceptional cases, it has been capitalized as production costs in both the commercial and tax balance sheets (discretionary option). Due to the principle of consistency, this option must be exercised uniformly in both the commercial and tax balance sheets (see para. 6 of the BMF letter dated March 12, 2010). This approach to capitalizing interest during the construction period may be of interest in terms of avoiding the otherwise applicable pro-rata addition (resulting in neutralization) of interest expense for trade tax purposes and for temporarily strengthening the equity ratio. Financing interest, as well as the interest component included in lease payments, must be partially added back off-balance-sheet to increase profit for trade tax purposes. If, on the other hand, the option is exercised and construction-period interest is capitalized, this interest is not to be added to profit on a pro-rata basis for trade tax purposes—neither in the year of capitalization nor in the years in which it affects profit through depreciation. For the sake of completeness, it should also be noted that, depending on the size of the company or the volume of total interest expense, the so-called interest deduction limit (Section 4h of the German Income Tax Act (EStG)) may, under certain circumstances, lead to a (at least temporary) restriction on deductible interest expense.
*The construction of a logistics center is a long-term project. Regarding questions about the recognition of profits on the balance sheet for long-term contracts from the perspective of, among others, general planners, I refer you to my guest article in //plus 01/2022.
**Regarding the issues that arise in this context in connection with long-term production, I refer you to my guest article in //plus 01/2022.
