Rent Abatement Accounting Under ASC 842

A rent abatement is an agreement in a commercial lease where a landlord grants a tenant a period of free or reduced rent. These arrangements can be offered to provide the tenant time to build out a new space or as a general incentive to sign the lease. The accounting guidance for all leases in the United States is the Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 842, Leases (ASC 842). This standard changed how companies account for leases by requiring most to be recognized on the balance sheet and provides a framework for handling abatements to reflect the true cost of a lease.

The Core Principle for Planned Rent Abatements

When a rent abatement is agreed upon at the start of a lease, ASC 842 treats it as a lease incentive. The principle is that the total cost of the lease must be recognized on a straight-line basis over the full lease term, regardless of the timing of cash payments. This approach ensures the expense recorded each month is uniform, providing an accurate representation of the cost of using the asset over time. The abatement reduces the total lease consideration, which is the sum of all payments required under the contract.

To implement this, a company calculates the total cash it will pay over the lease’s life, subtracting the abatement’s value. This net amount is then divided by the total number of months in the lease term to determine the monthly straight-line lease expense. The difference between the straight-line expense and the actual cash paid each month is recorded as an adjustment to the lease liability and the Right-of-Use (ROU) asset on the balance sheet.

Calculation and Journal Entry Examples

Consider a 5-year (60-month) lease with a monthly rent of $10,000, where the landlord grants a rent abatement for the first three months. The first step is to calculate the total cash payments. The tenant will pay rent for 57 months (60 months minus 3 free months) at $10,000 per month, resulting in total cash payments of $570,000.

Next, the straight-line monthly lease expense is determined by dividing the total payments by the total lease term. In this example, $570,000 is divided by 60 months, which equals a monthly lease expense of $9,500. This amount is recorded on the income statement each month for the entire term, including the abatement period.

At the lease’s start, an initial journal entry records the Right-of-Use (ROU) Asset and Lease Liability on the balance sheet. The value is the present value of the future lease payments. Assuming the present value of the $570,000 in payments is $525,000 using an appropriate discount rate, the entry would be a debit to ROU Asset for $525,000 and a credit to Lease Liability for $525,000.

During the first three abatement months, the journal entry recognizes the expense without any cash outflow. Each month, the company debits Lease Expense for $9,500. The Lease Liability increases by the interest accrued on its balance, while the ROU Asset is credited for the difference between the straight-line expense and the interest. For instance, if interest on the liability for month one is $2,188, the liability increases by that amount, and the ROU asset is credited for $7,312 ($9,500 – $2,188).

Once cash payments begin in the fourth month, the journal entry changes. The company will debit Lease Expense for $9,500 and credit Cash for the $10,000 payment. The Lease Liability is then debited for the portion of the payment that covers the principal, which is the cash paid less the interest expense for that period.

Treatment of Unforeseen Rent Concessions

Rent concessions not part of the original lease agreement are accounted for differently than planned abatements. These situations can arise from unexpected events, like economic distress or property damage that makes a space unusable. The accounting treatment depends on whether the concession is a lease modification, which is a change to the contract’s terms not part of the original agreement.

If a concession is a lease modification, the lessee must remeasure the lease liability using an updated discount rate as of the modification date. The Right-of-Use (ROU) asset is then adjusted by a corresponding amount. This process treats the change as a new agreement going forward, altering the future accounting for the lease.