Income and expenses always have to be recorded in a period, to which they relate in terms of facts and time; now how to record lease incentives or, in other words, discounted rent or free rent?
A lessor’s goal is to arrange for a long-term lease in order to provide for long-term income, and certain advantages are therefore offered to entities. Those advantages are defined in a lease agreement and include lease incentives, such as the frequently used “rent free”.
Rent free is usually included as a provision in a particular agreement. The benefit can either be short-term or long-term. A situation often occurs where the lessor “remits” the first and final rent.
Other types of incentives include reimbursing costs of moving into newly rented premises or paying the termination payment from the original lease.
The National Accounting Council (NÚR) deals with the topic of incentives, specifically with the interpretation thereof, in NÚR I-17: Incentives in Lease Relationships.
What benefits should be, as a consequence, recorded on an accruals basis?
Where the provided benefit can be considered provided exclusively for the purpose of obtaining a new tenant or extending the contractual relationship with an existing tenant, such benefit is identified as an incentive and should be recognized on an accruals basis over the entire term of the agreement, to which it relates, not only on the tenants side but also on the lessor’s side.
In this case, the term is a period, for which the lease will be provided without a possibility to terminate it or where it would be unfavorable for the tenant to terminate the lease to an extent such that it renders the termination unlikely.
If the lease relationship has been entered into for an indefinite period, the agreement’s term is the notice period rather than the estimated term of the lease’s enjoyment.
What benefits should not be recorded on an accruals basis on the other hand?
Where the lessor provides a benefit for a reason other than those mentioned above (e.g. a rent discount due to a limited use of the leased premises), such benefit should not be considered an incentive and should not be recorded on an accruals basis.
Who is to decide whether an incentive is involved or not?
The entity’s professional judgment has to be used. In considering if an incentive is involved, professional judgment of the other contracting party can be taken into account.
An example of recognizing a lease incentive for a period of five years from the tenant’s perspective:
Year | Level of the rent | Recorded debit/credit | Amount |
1 | 150 | 518/321 | 150 |
|
| 518/383 | 210 |
2 | 200 | 518/321 | 200 |
|
| 518/383 | 160 |
3 | 350 | 518/321 | 350 |
|
| 518/383 | 10 |
4 | 550 | 518/321 | 550 |
|
| 383/518 | 190 |
5 | 550 | 518/321 | 550 |
|
| 383/518 | 190 |
Total | 1,800 | X | X |
Average | 360 | x | x |
The tenant should quantify the value of the whole five-year lease and calculate an average annual amount of the rent. In our case, the average annual rent will be 360.
In year 1, the tenant will record a reduced rent in the amount of 150 based on an invoice, and the remaining portion from the rent’s average annual amount will be carried on account no. 383 – accrued expenses. The tenant will record the rent in the concerned amount for the next two years and the remaining portion up to the level of the rent’s average annual amount will also be recognized through account no. 383 - accrued expenses.
In years 4 and 5, the rent exceeds the rent’s average annual amount and, as a result, the tenant will recognize that amount to account no. 383 - accrued expenses, thus reducing costs of the lease in the particular year to the level of the rent’s average annual amount.
An analogical procedure would then be applied by the lessor who would use account no. 385 – accrued income.
