This post will explain the correct way to account for tenant improvement allowances and other lease incentives under the current GAAP lease accounting rules (click here to learn about the new lease accounting rules). It is composed of two parts. The first will cover the correct way to to account for tenant improvement allowances under the current GAAP rules and the second will cover accounting for them when a lease renews:

Note that references to “lease incentives” in this article refer to any payments made to the tenant by the landlord or on behalf of the landlord. This includes reimbursements for moving expenses, payments for tenants to break existing leases, and payments for tenant improvement allowances, even if the tenant never receives cash and simply submits invoices to the landlord for a prescribed amount of leasehold improvements that the lessor has agreed to fund.

REMINDER: Feel free to send your lease accounting questions to us at info@leasequery.com.

How to Account for Tenant Improvement Allowances under the Current GAAP Lease Accounting Rules

Let me begin by telling you the entry not to make. When you receive a tenant improvement allowance, the wrong entry to make is a debit to cash and a credit to leasehold improvements. The FASB has expressly stated that incentives received should not be netted against leasehold improvements, yet this is what we often see some companies are doing and it is incorrect.

Download the lease accounting transition guide for ASC 842 and IFRS 16

The correct entry is to record the payment as a liability, which is amortized (as a reduction to rent expense) over the life of the lease. Here is a quick 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. The total cost of the leasehold improvements is $20,000.

The entries to make are as follows:

Account Debit Credit
Cash 1,000  
Lease Incentive Liability   1,000

To record receipt of the tenant improvement allowance

Account Debit Credit
leasehold improvements 20,000  
Cash   20,000

To record payment for total leasehold improvements by tenant

Account Debit Credit
Rent Expense 1,500  
Cash   1,000
Deferred Rent   500

To record rent payment in Yr 1 (Straight-line expense: 15,000 total pmts divided by 10 yr term)

Account Debit Credit
Lease Incentive Liability 100  
Rent Expense   100

To amortize the tenant improvement allowance (Straight-line: 1,000 TIA divided by 10 yr term)

You can combine entries 3) and 4) above as follows:

Account Debit Credit
Rent Expense 1,400  
Lease Incentive Liability 100  
Cash   1000
Deferred Rent   500

To record rent payment in year 1 AND amortize tenant improvement allowance

Update: Here is a video on how to account for tenant improvement allowances

Note that as a result of the tenant improvement allowance, rent expense each year is $1,400 instead of $1,500. A common question we get asked is how the entries would be different if the tenant never receives the cash, that is, if the tenant submits invoices to the landlord and the landlord pays the contractor directly. In that case, rather than debiting cash in the first entry, you would debit leasehold improvements, as follows:

Account Debit Credit
leasehold improvements 1,000  
Lease Incentive Liability   1000

To record allowance paid directly to contractor for leasehold improvements

Account Debit Credit
leasehold improvements 19,000  
Cash   19,000

To record leasehold improvements paid by tenant

These entries can be combined as follows:

Account Debit Credit
leasehold improvements 20,000  
Cash   19,000
Lease Incentive Liability   1,000

To record total leasehold improvements and Allowance paid directly to contractor by the landlord

Note that the $1,000 paid directly to the contractor by the landlord would be reported as a non-cash transaction on the cash-flow statement.

There you have it – how to account for tenant improvement allowances under current accounting rules. Please note that under the proposed new lease accounting rules, accounting for tenant improvement allowances will be very different.

Accounting for Tenant Improvement Allowances when a Lease Renews

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.

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 incorrect. 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.

Base Rent Amortization Schedule (Initial Lease)

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.

TI Allowance Amortization Schedule (Initial Lease)

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.

Base Rent Amortization Schedule (Renewed Lease)

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.

TI Allowance Amortization Schedule (Renewed Lease)

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.


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