If there is one thing that just about everyone gets excited about it is receiving something free. For those organizations that rent or lease and have the benefit of free rent for a time period in their contract, I wanted to quickly go over the proper GAAP treatment. You may not be aware that the “free” months still must be recorded as rent expense in the accounting records.
The first step is to calculate the total payments over the term of the contract or lease. For our purposes, let’s assume a 5 year operating lease with monthly payments of $4,500 and the first six months of rent abated. The sum of cash payments for months 7-60 would be $243,000 ($4,500 x 54 = $243,000).
The next step would be to allocate the total rent expense over the life of the lease. Therefore, we would allocate the $243,000 over the 60 months to give us $4,050 per month of lease expense ($243,000/60 = $4,050). This would be the amount of rent expense that we would record over the life of the lease (including the six months free). Additionally, we would record an accrued lease liability for the six months of abated rent.
Let’s now look at what our journal entries would look like. For the first six months of free rent we would record:
Rent expense: $4,050
Accrued lease liability: $4,050
This would give us a total liability of $24,300 after month six. We then would amortize this liability over the remainder of the lease. In months seven through 60 we would start making the $4,500 rent payments and record the $4,050 of rent expense calculated as in the first six months. The remaining difference of $450 will be a reduction of the accrued liability until the end of the lease term.
Rent expense: $4,050
Accrued lease liability: 450
This is a situation that does not occur every year, but is important to keep in mind when it is applicable as it can have a significant impact on financial reporting. We have a knowledgeable staff that is well versed on GAAP reporting requirements and would be happy to answer any such questions or be of service to you or your organization in whatever way we can.
Tags: Abatement, free rent, lease, lease agreement, rent, rent abatement