Accounting For Tenant Improvement Allowance

Tenant Improvements can be described as the renovations or customizations that are made to a said property in order to benefit the tenant. However, the said alterations are only meant to be applicable to improvements in the rented space, like the office. They do not include building improvements that are made outside of the given space.

Tenant Improvement Allowance can be described as a fund that a landlord provides in order to pay for the improvements in the rented property, which is occupied by the tenant. Therefore, this is the amount that is paid for improvements that are made to the leased space. These allowances mostly include costs that are incurred when the tenant occupies a new property. Examples of costs that are covered under the Tenant Improvement Allowance include upgradation or maintenance of floors, windows, or other fixtures and fittings at the rented property.

Classification And Categorization

Under most circumstances, landlords provide for Tenant Improvement Allowances to cover both, hard, as well as soft costs that are associated with any renovation to the rented space.

Hard costs are defined as improvements to the property that the tenant is likely to leave behind, which in return imply will benefit the landlord. Examples of hard costs under tenant improvement allowances include new flooring, electrics, HVAC, or any other permanent (irremovable) fixtures and fittings.

Soft Costs, on the other hand, include costs like management fees.

It must also be noted that Tenant Improvement Allowance mostly does not include any costs that are meant to cater to the tenant’s specific needs, and therefore, fail to provide any additional value to the landlord.

In the same manner, tenant improvement allowances do not cover any removable alterations. Some examples of expenses that are not covered under Tenant Improvement Allowance include electronic equipment, new furniture and fittings, as well as any new amendments that are specifically catered in accordance with the needs of the tenant.

Accounting For Tenant Improvement Allowance

The lessor of a given property mostly transfers Tenant Improvement Allowance to improve the condition of the leased property. The accounting treatment for this particular transaction is mostly contingent on the understanding between the lessor and the lessee regarding the ownership of the improvements, as well as the possibility of a direct reimbursement arrangement. The various different possibilities regarding Tenant Improvement Allowance are as follows:

  • Lessee owns the Tenant Improvement: In the case where the lessee owns the tenant improvements, it can be seen that the lessee records the allowance as an incentive. This is a deferred credit, by nature. The Tenant Improvement Allowance in that case is amortized either across the tenancy term, or the useful life of the said improvements, without any residual value. However, mostly term of the lease is used as an amortization period. It is categorized as a negative rent payment in this case.
  • Lessor owns the improvements: In the case where the lessor bears ownership of the Tenant Improvements, the lessor mostly records the expenditure as a fixed asset, which is then depreciated over the useful life of the said asset. In the case where the tenant moves out, and terminates the lease prior to the end of the depreciation period, the lessor continues to depreciate under the original depreciation collection. In the case where the building is damaged, the lessor is then supposed to write off the remaining undepreciated balance of the expenditure, which then appears in the Income Statement as a loss.
  • Flow-through Arrangement: If the lessor directly pays the lessee for the cost of Tenant Improvements, it is referred to as a flow-through arrangement. In this case, the lessee does not record any fixed asset that is associated with the payments made. In fact, the lessee mostly initially pays for the leasehold improvements, and those payments are then offset by payments that are received from the lessor.

Journal Entry To Record Tenant Improvement Allowance

In order to record Tenant Improvement Allowance, the following journal entries are made:

To record Tenant Improvement (Lessee’s Books)

Account Debit Credit
Fixed Asset Improvement xxx
Cash xxx

To record Tenant Improvement paid by Lessor (Lessee’s Books)

Account Debit Credit
Cash xxx
Lease Incentive Liability xxx

The Lessee also needs to amortize the lease improvements that are based on the useful life of the asset. This is done using the following journal entries:

Account Debit Credit
Depreciation Expense xxx
Accumulated Depreciation xxx

To record amortization of the lease incentive (Lessee’s Books):

Particular Debit Credit
Lease Incentive Liability xxx
Rental Expense xxx

Example Of Tenant Improvement Allowance

Hings Co rented an office building from Grizzly Inc. for a period of 10 years at a rate of $2000 per month. The total cost of renovation incurred on the premises is $10,000, and it is expected to derive utility for a period of 10 years. However, Hings Co has requested the tenant improvement allowance from the landlord. Once the review was duly conducted, Grizzly Inc. decided to provide an allowance equivalent to $8,000, since this amount met the criteria for tenant improvement allowance. They believe this will add value to the existing property, and therefore, they were ready to invest on behalf of the tenant. It was decided that the allowance would be paid through reimbursement.

In the scenario mentioned above, the tenant improvement allowance is recorded as a fixed asset in the financial statements of Grizzly Inc. However, since this investment has an expected utility equivalent to 10 years, it will be depreciated over the life of the asset. The journal entries to record this would be as follows:

Account Debit Credit
Fixed Asset Improvement $10,000
Cash $10,000

After this amount is reimbursed, the following journal entries will be made:

Account Debit Credit
Cash $8,000
Lease Incentive Liability $8,000

In the same manner, when the rental fee is paid, the following journal entries are made:

Account Debit Credit
Rental Expense $2,000
Cash $2,000

At the end of the year, Lease Incentive Liability is reclassified, as a credit to the rental expense. It reduces the monthly rental amount equivalent to the expense that is made. To record this, the following journal entries are made:

Account Debit Credit
Lease Incentive Liability $800
Rental Expense $800