Why Your Accounting for Tenant Improvement Allowances is Dead Wrong.

Russell Bowles Tenant improvement allowance accounting

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

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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 what some companies are doing. And it is wrong.

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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. We will address that in a different post.

 


 

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