Accounting for Tenant Improvement Allowances
Tenant improvement allowances (TIAs) are treated as lease incentives under ASC 842. Incentives always reduce the right-of-use asset, but their specific accounting treatment depends on when the incentive payment is received.
TIAs received before lease commencement
TIAs received before lease commencement are recorded as a liability.
| Account | Debit | Credit |
|---|---|---|
| Lease Incentives | 10,000 | |
| Cash | 10,000 |
On lease commencement, the incentive liability is reclassified to right-of-use asset. This clears the incentives balance and reduces the right-of-use asset by the TIA amount.
| Account | Debit | Credit |
|---|---|---|
| Lease Incentives | 10,000 | |
| Right-of-Use Asset | 10,000 |
TIAs received after lease commencement
TIAs paid after lease commencement are treated as an incentive that reduces lease payments. From an accounting perspective, the incentive is essentially a negative lease payment. The best way to explain how to account for incentives received during the lease term is with a concrete example.
- Term: 5 years
- Annual Rent: 5,000 (paid in advance)
- TI Allowance: 6,000 (paid at the start of year two)
- Discount Rate: 5%
| Rent | TIA | Total Payment | Expense | Interest | Amortization | Asset | Liability |
|---|---|---|---|---|---|---|---|
| 18,818.29 | 18,818.29 | ||||||
| 5,000.00 | 0.00 | 5,000.00 | 3,800.00 | 57.58 | 3,763.66 | 15,054.63 | 13,875.86 |
| 5,000.00 | (6,000.00) | (1,000.00) | 3,800.00 | 61.98 | 3,763.66 | 11,290.97 | 14,937.85 |
| 5,000.00 | 0.00 | 5,000.00 | 3,800.00 | 41.41 | 3,763.66 | 7,527.31 | 9,979.25 |
| 5,000.00 | 0.00 | 5,000.00 | 3,800.00 | 20.75 | 3,763.66 | 3,763.66 | 5,000.00 |
| 5,000.00 | 0.00 | 5,000.00 | 3,800.00 | 0.00 | 3,763.66 | 0.00 | 0.00 |
As demonstrated by the above amortization schedule, the total lease payments over the lease term is equal to the rent payments less the TIA payment in year two, or 19,000 = (5,000 × 5) − 6,000. The rest of the amortization schedule behaves just like a typical operating lease.
TIAs with an unknown date
The lease accounting for both pre-commencement and post-commencement incentives is straight forward, but reality isn’t always so simple. TIAs are often structured so that the lessee is reimbursed for their spending on improvements, up to some maximum amount. In those cases the precise amount and timing of the incentive aren’t known at lease commencement. How do you handle the accounting of a lease incentive when you don’t know exactly when you’ll receive the allowance?
Even when the timing and amount of TIA payments is unknown, it’s unlikely a lessee would forgo the incentive. Because of this, lessees should treat TIAs as an “in substance fixed payment,” and include their best estimate of the incentive in the initial lease measurement. After lease commencement, once the actual amount and payment timing of the incentive is known, the lessee should remeasure the lease liability and right-of-use asset to reflect the true incentive, using the same discount rate used at lease commencement.
For a more rigorous explanation, check out this detailed example in PwC’s lease accounting guide.
Christian Vanderwall
VP Engineering