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Why Your Accounting for Tenant Improvement Allowances is Dead Wrong.

Tenant Improvment Allowances

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).

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:

1)      DR    Cash                                         1,000

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. Please leave questions or comments below.

About LeaseQuery:  LeaseQuery is lease accounting software that helps companies manage their leases.  Rather than relying on excel spreadsheets, our clients use LeaseQuery to get alerts for critical dates (renewals, etc), calculate the straight-line amortization of rent and TI allowances per GAAP, provide the required monthly journal entries (for both capital and operating leases) and provide the commitment disclosure reports required in the notes and the MD&A.  Visit us at www.LeaseQuery.com

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