This post will explain, under ASC 840, how to account for a lease when the tenant expands the leased premises, but the expansion was not required under the terms of the initial lease. These lease amendments that expand the leased space can be a bit tricky.

Keep in mind that this scenario assumes that the lessee is deciding to expand the leased premises but had no obligation to do so in the original lease agreement.

Under ASC 840, when a lease is amended to expand the leased premises, then for accounting purposes that amendment is considered a new lease, and any deferred rent under the prior lease should be included in the straight-line rent expense calculation for the new lease term.

In other words, whenever a tenant expands an existing lease, there should be a new straight-line expense schedule. The new schedule should straight-line the following 5 items over the new lease term:

- The new payments of the original space
- The new payments for the expanded premises
- The balance in deferred rent prior to the expansion
- The unamortized tenant improvement allowance (TIA) prior to the expansion, and
- Any new tenant improvement allowances for the expanded premises.

Let us illustrate the accounting for this scenario using a comprehensive example:

Assume a tenant enters into a 10-year lease with a Landlord for one floor of a high-rise building. The payment terms are 10,000/month with an annual increase of 3%. Assume the Landlord granted the tenant a tenant improvement allowance of $80,000. Also assume that it is an operating lease, and the possession and commencement date of the lease are on January 1, 2012. (Click here to learn about the difference between the commencement date and the possession date).

Now assume that on January 1, 2016, the tenant signs an amendment to the original lease to rent an additional floor in the building, with payment terms of 15,000/month and annual increases of 4%. For the additional floor, the Landlord grants the tenant an additional $100,000 in tenant improvement allowances.

The payment terms for the initial floor remains unchanged. Assume that the tenant also gets access to the second floor on January 1, 2016, and the end date of the total leased premises remains unchanged (December 31, 2021).

The following is the accounting treatment for the above example:

The lease for the first floor and its concomitant tenant improvement allowance of $80,000 would be straight-lined over a 10-year period, and the amortization schedule looks like this:

Note that the total rent expense on the income statement is $129,567 because the tenant improvement allowance of $80,000 is also amortized over the lease term (click here to read how to account for tenant improvement allowances).

As stated above, when a lease is amended to expand the leased premises, then for accounting purposes that amendment is considered a new lease, and any deferred rent under the prior lease should be included in the calculation of straight-line rent expense for the new lease term.

To simplify, we will address the base rent and the tenant improvement allowances separately.

The new lease term of the total lease is 6 years (recall that the end date remained unchanged). Base rent expense is calculated as the total lease payments adjusted by the deferred rent balance from the initial lease divided by the lease term. So the** new base rent** expense is** $336,556**.

Note that the **expense calculated is NOT $344,594**, because that amount does not adjust for the beginning deferred rent balance of 48,231 as of January 1, 2016. Please see schedule 2 showing the new amortization schedule for base rent.

Once again, for simplicity, we are addressing the tenant improvement allowances separately from base rent. The new tenant improvement allowance is calculated as the prior unamortized TIA plus the new TIA amortized over the new lease term. The unamortized balance of the TIA as of January 1, 2016 is 48,000 (per schedule 1). This amount is added to the new TIA granted for the second floor of $100,000, resulting in a total unamortized TIA of $148,000. That balance is now amortized over the new lease term of 6 years, resulting in a schedule as follows:

Note that the adjustment (reduction) to rent expense each year changes from $8,000 prior to the expansion to $24,000 after the expansion. Also notice that total rent expense changes from $129,567/yr prior to the expansion to $311,889 after the expansion. Please see schedule 4 below.

Once again, the main take away from this example is this: Whenever a tenant expands an existing lease, there should be a new straight-line expense schedule. The new schedule should straight-line the following 5 items over the new lease term:

- The new payments of the original space (in this example, those payments were unchanged)
- The new payments for the expanded premises
- The balance in deferred rent prior to the expansion
- The unamortized TIA prior to the expansion, and
- Any new TIA for the expanded premises.

Let us stress that the accounting treatment we described in this post would also apply if the tenant expanded by leasing a larger space in a completely different building, as long as it is leased from the same landlord.

Note that LeaseQuery handles this scenario perfectly with ease. All the user needs to do is enter the new lease payments and the new tenant Improvement Allowances, and LeaseQuery spits out the following amortization schedule for base rent:

Note that the monthly base rent expense of 11,463.87, calculated by the system prior to the expansion, equals the annual expense of 137,567 that we calculated in schedule 1 above divided by twelve. Likewise, the base rent expense of 28,046 after the expansion is the annual expense of 336,556 from schedule 2 divided by twelve.

LeaseQuery also prepares the amortization schedule for the tenant improvement allowance:

Note that the monthly TI amortization of 666.67 calculated by the system prior to the expansion equals the annual adjustment to base rent of 80,000 that we calculated in schedule 1 above divided by twelve.

Likewise, the monthly TI amortization of 2,055.56 after the expansion is the annual expense of 24,667 from schedule 3 divided by twelve. The amortization for the TIA is negative in the schedules to indicate that they are reductions in rent expense.

Thank you for reading our blog, and if you have any questions please leave a comment below. We’d love to hear from you.

Very helpful article! Taking it a little further, should a landlord fee charged for oversight of a TI allowance be netted against the lease incentive?

Hi Michelle, thank you for your comment! Yes, the situation you mentioned sounds like the landlord fee would be netted against the lease incentive as they did not reimburse for that administrative cost.