Why Your Accounting for Tenant Improvement Allowances is Dead Wrong.

Russell Bowles Blog

In this post I will explain the correct way to account for tenant improvement allowances and other lease incentives under current GAAP lease accounting rules.  Note that incentives refer to any payments made by the landlord to (or on behalf of) the tenant. 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 lessor for a prescribed amount of leasehold improvements that the lessor has agreed to fund).

Before we get into this, we would like to remind our readers that you can always send your lease accounting questions to us at info@leasequery.com. (Click here for a blog we wrote in response to a question we received about how to account for a lease when early access is granted to part of a building at first, then the rest later). At LeaseQuery, we do not just provide lease management software, we provide lease management AND accounting software. Trust us, there’s a difference. (Click here for a demo of our lease accounting software).  Now that we’ve addressed those housekeeping issues, let’s delve into today’s topic: accounting for tenant improvement allowances.

 

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 companies doing. And it is wrong.

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:
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1)      DR    Cash                                         1,00

         CR     Lease Incentive Liability       1,000

To record receipt of the tenant improvement allowance

 

2)      DR    Leasehold Improvements   20,000

         CR    Cash                                         20,000

To record payment for total leasehold improvements by tenant

 

3)      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)

 

4)       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)

 

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

DR    Rent Expense                        1,400

DR    Lease Incentive Liability      100

CR     Cash                                       1,000

CR     Deferred Rent                      500

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

Note that as a result of the tenant improvement allowance, rent expense each year is $1,400 instead of $1,500.  A common question I 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 lessor and the lessor pays the contractor directly. In that case, rather than debiting cash in the first entry, you would debit leasehold improvements, as follows:

DR    Leasehold Improvements    1,000

CR     Lease Incentive Liability       1,000

To record allowance paid directly to contractor for leasehold improvements

 

DR    Leasehold Improvements    19,000

CR    Cash                                         19,000

To record leasehold improvements paid by Tenant

 

These entries can be combined as follows:

 

                 DR    Leasehold Improvements    20,000

CR Cash                                            19,000

CR Lease Incentive Liability           1,000

To record total leasehold improvements and allowance paid directly to contractor by 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. I will address that in a different post.

 

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:

Accounting for Tenant Improvement Allowances when a Lease Renews

How to Account for Lease Amendments that Expand the Leased Premises

Lease Accounting when Tenant Must Return the Asset to its Initial Condition

Accounting for Leases with Termination Options

Accounting for Subleases under GAAP: The CORRECT way

Lease Accounting: When early access is granted to part of a building at first, then the rest later

 

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