In a previous blog post I explained how to account for tenant improvement allowances on a new operating lease under GAAP. In this post, I will explain how to account for the initial (previous) tenant improvement allowance when an operating lease is renewed. Recall from my previous post about tenant improvement allowances that when you receive a tenant improvement allowance, it should be recorded as a liability which is amortized (as a reduction to rent expense) over the life of the lease. If the lease is extended as part of a renewal, the unamortized balance of the initial tenant improvement allowance should be amortized over the remaining term of the revised lease. editor’s note: watch our latest video on tenant improvement allowances for free here What we see often is that companies just continue to amortize the TI Allowance over the initial lease term without adjusting the amortization period to reflect the new lease term. This is NOT GAAP and it is WRONG. Companies that do that are essentially understating expense. In order to understand the correct accounting, here is an example: Assume a tenant enters into a 10 year operating lease requiring the tenant to make payments of $1,000 in years 1-5 and $2,000 in years 6-10. In order to induce the tenant to enter into the lease, the landlord agrees to provide funding of up to $1,000 for leasehold improvements. Now let’s assume that at the end of Year 6, the company decides to extend/renew the lease for an additional 4 years, and the payments are now $2,500 in years 7-10 and 3,000 in years 11-14. The journal entry to record the incentive under the initial lease is as follows: 1) DR Cash 1,000 CR Lease Incentive Liability 1,000 To record receipt of the tenant improvement allowance The journal entry to record the lease payment in Yr 1 is as follows: 2) DR Rent Expense 1,500 CR Cash 1,000 CR Deferred Rent 500 To record rent payment in Yr 1 (Straight-line expense: 15,000 total pmts divided by 10 yr term). See Base Rent Amortization Schedule For Initial Lease Below.
The journal entry to record amortization of the Tenant Improvement Allowance is: 3) DR Lease Incentive Liability 100 CR Rent Expense 100 To amortize the tenant improvement allowance (Straight-line: 1,000 TIA divided by 10 yr term) See TI Allowance Amortization Schedule For Initial Lease Below.
Now let’s make the journal entries for the renewal. Recall that at the end of Year 6, the company decides to extend/renew the lease for an additional 4 years, and the payments are now $3,000 in years 7-10 and $4,000 in years 11-14. Based on this, the new lease term is 8 years (years 7 through 14).
The entry to record payment in year 7 is as follows: 1) DR Rent Expense 3,250 CR Cash 3,000 CR Deferred Rent 250 To record rent payment in Yr 7 (Straight-line expense: 28,000 total payments less 2,000 balance of deferred rent in Yr 6 divided by 8 yr term). See Base Rent Amortization Schedule For Renewed Lease Below.
The journal entry to record amortization of the Tenant Improvement Allowance after the renewal is as follows: 3) DR Lease Incentive Liability 50 CR Rent Expense 50 To amortize the tenant improvement allowance (Straight-line: 400 Balance of unamortized TIA divided by 8 yr term) See TIA Amortization Schedule for Initial Lease Below.
Notice that the net rent expense for the initial lease was $1,400 each year, while the net rent expense for the renewed lease is $3,200. Let me stress that with LeaseQuery, these calculations are done automatically by the system. You simply enter the new rent payments per the renewal, and LeaseQuery automatically calculates your new base rent expense adjusted for the previous deferred rent and automatically adjusts the TI Allowance as required by GAAP. As you go about selecting lease accounting software, be sure that the software provider shows you how the system does this during the demo. The last thing you want is to make these adjustments manually using Excel, as it defeats the purpose of lease accounting software.
Here is a free tool you can use to determine if your lease is a Capital or Operating Lease. It goes though the 4 tests for capital leases. To access the test (for free), click here. If you liked this post, then you will enjoy some of our other articles:
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