What it means
Imagine renting a delivery van for a flat $2,000 a month that includes insurance, servicing and road tax. Only part of that payment buys the right to use the van; the rest buys services the owner happens to provide, and those services are ordinary operating expenses.
The reason this matters is measurement. A lease liability is the present value of the payments for the asset, so including insurance and maintenance would overstate both the liability and the corresponding asset on the balance sheet.
In practice, the finance team asks the lessor to split the invoice or estimates the service portion from market prices. Insurance and property tax are usually easy to identify, while maintenance often needs a comparable quote from an independent provider.
Terminology has shifted with newer standards. Modern lease accounting talks about non-lease components rather than executory costs, and it allows a practical expedient where a lessee may choose not to separate them, at the price of a larger recorded liability.
The nuance to watch is that variable executory amounts do not usually enter the liability at all. If the tenant reimburses actual property taxes as they arise, those payments are expensed as incurred rather than capitalised, which keeps the liability stable even when service costs move.
In practice
Real-world examples.
Example
A logistics firm leases forty trucks on full service contracts. Splitting out maintenance and insurance of $340 per truck per month reduces the recorded lease liability by several million dollars and moves that cost into operating expenses instead.
Example
A dental practice leases imaging equipment where the monthly fee includes a service plan. The accountant obtains a standalone service quote from the manufacturer and uses it to allocate the payment between the lease component and the service component.
Example
A retailer signs a shopping centre lease with a base rent plus a share of actual centre running costs billed quarterly. Because the service charge varies with actual spending, it is expensed as billed rather than included in the lease liability.
Think of it
“Executory costs are the operating expenses that come with leased property-insurance, maintenance, taxes.
Formula
Calculation
Net lease payment = gross contractual payment - executory costs included in that payment
A company leases warehouse space for a gross payment of $7,000 per month, and the landlord's schedule shows that $1,000 covers building insurance, property tax and common area maintenance. The net lease payment used for measurement is $7,000 - $1,000 = $6,000 per month.
Over a five year lease the gross commitment is $7,000 x 60 = $420,000, while the executory portion is $1,000 x 60 = $60,000, leaving $360,000 of lease payments to be discounted into the liability. The $60,000 of executory costs is charged to operating expenses as the periods pass, so total cost is unchanged but the balance sheet presentation is very different.Case study
Seen in the real world.
Here is an illustrative example built around a fictional business. Calder Fleet Services, an invented regional courier company, leased its entire van fleet on all inclusive contracts and initially recorded the full monthly payment as a lease commitment. Its recorded lease liability came out at $6,200,000, which pushed its debt to equity ratio past a covenant threshold in its bank facility.
On review, roughly 22% of each payment covered insurance, servicing, tyres and road tax rather than use of the vehicle. Stripping the executory element reduced the measured liability to about $4,840,000 and moved around $1,360,000 into operating expenses over the lease term.
In this fictional case the total cost to Calder was identical either way, but the covenant test passed comfortably and the bank did not need to renegotiate the facility. The finance director's real lesson was to request component pricing from lessors before signing rather than trying to unpick invoices afterwards.
Watch out
Common mistakes.
- Capitalising the entire gross lease payment when the invoice clearly bundles insurance and maintenance, which overstates both the asset and the liability.
- Guessing at the service portion without any supporting evidence, leaving the allocation impossible to defend in an audit.
- Including variable service charges in the lease liability when they are reimbursements of actual costs and belong in operating expenses as incurred.
Questions
People also ask.
Are executory costs and non-lease components the same thing?
They describe the same underlying idea, with non-lease component being the term used by current lease accounting standards.
Can a business simply choose not to separate them?
Many standards permit that practical expedient by class of asset, but the trade off is a larger lease liability and a bigger reported asset.
How do I work out the split if the lessor will not tell me?
Use observable standalone prices for the same services from independent providers and document the basis of the estimate in the accounting file.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%