Accounting for Tenant Improvement Allowance

Tenant Improvement Allowance (TI allowance) is the sum of money that the lessor paid to lessee regarding the improvement of leasehold property. The lessee has customized the leasehold property and it adds long-term value to the property, so lessor agrees to pay for the improvement.

When the tenant rents the property, they may want to customize or renovate base on their requirement. The leasehold property is already in good condition and ready to use, but the tenant wants to change it base on their brand.

The landlord agrees to pay for this improvement because they feel that it will provide value to the leasehold property in the long term. The leasehold improvements will improve the property, so it will benefit the lessor who can increase the price later. The landlord will cover both the hard and soft expenses of the tenant improvement allowance.

It is the customization or renovation that lessor provide to meet the definition of the tenant. And the benefit is longer than the lease contract. It is not include the surrounding area of the leased property.

It is up to the landlord to access the improvement before approve it as the tenant improvement allowance. As it is very subjective to access the benefit remains after the lease contract.

Tenant Improvement Allowance Example

Company ABC lease the office building to Company XYZ. The property is in good condition and ready to use. However Company XYZ decides to change some decorations to reflect their requirement, it includes:

  • Painting
  • Build conference room
  • Build Breakroom
  • Merge some rooms
  • Door, window, framing…

These renovations are the tenant improvement allowance as they provide value to the building. Even company XYZ end the contract, these value still exist in the building which will benefit to company ABC. So company agrees to pay for these renovations by allowing the tenant to hire and design the work and reimburse later.

Accounting Treatment

There are several options which both lessee and lessor treated the tenant improvement allowance:

Record as Lessee assets

The tenant improvement allowance can be own by the lessee when there is no requirement to modify the property. Moreover, the improvement does not:

  • Provide benefits to a subsequent tenant
  • Increase the fair value of property
  • The improvement does not exceed the lease term

If the improvement meets the above criteria, the lessee must record it as their owns assets and amortize over its useful life. The lessor payment will record as the lease incentive liability and amortize over the lease term.

Tenant Improvement Allowance Journal Entry

  • To record the leasehold improvement (Lessee book)

The lessee needs to record it as the fixed assets improvement and present it on the balance sheet. This fixed asset’s useful life will depend on the lease contract rather than the actual useful life.

Account Debit Credit
Fixed Assets_Improvement 0000
Cash 0000
  • To record the tenant improvement paid by a lessor (Lessee book)

When the lessor pays the TIA, the lessee needs to record it as the lease incentive liability and cash received. The lease incentive will be reversed every month and reduce the rental expense.

Account Debit Credit
Cash 0000
Lease Incentive Liability 0000
  • Lessee needs to amortize the lease improvement based on the useful life (Lessee book)

The fixed assets improvement needs to depreciate as normal depending on the lease contract. At the end of the lease contract, the fixed assets improvement will be zero.

Account Debit Credit
Depreciation Expense 0000
Accumulated Depreciation 0000
  • To record the amortize of lease incentive

Lease incentive liability is also required to amortize as well. It will reduce the tenant’s monthly rental expense.

Account Debit Credit
Lease Incentive Liability 0000
Rental Expense 0000

Tenant Improvement Allowance Example

Company XYZ rents an office building to company BZ for $ 5,000 per month, the lease term is 10 years. BZ has renovated the building before moving in, the total cost of renovation is $ 10,000 and expect to use for 10 years. They have requested the tenant improvement allowance from the landlord. After the review, XYZ only provides an allowance for only $ 8,000 which meets the criteria for tenant improvement allowance, they believe this renovation will benefit to next tenant. This allowance will be provided through reimbursement.

Due to the criteria, the tenant improvement allowance will be recorded as fixed assets in BZ’s financial statement. BZ will record the following journal entry:

  • BZ needs to record leasehold improvement as part of fixed assets when they renovate the building. This fixed asset needs to depreciate over the useful life of 10 years.
Account Debit Credit
Fixed Assets_Improvement 10,000
Cash 10,000
  • When XYZ reimburses the TIA, BZ needs to record lease incentive liability which needs to amortize over the lease term.
Account Debit Credit
Cash 8,000
Lease Incentive Liability 8,000
  • When BZ pay a rental fee of $ 5,000 to the landlord
Account Debit Credit
Rental Expense 5,000
Cash 5,000
  • At the end of the year, BZ to reclass the lease incentive liability as the credit of rental expense. It will reduce the monthly rental as an incentive from the property owner. $ 800 = $ 8,000 / 10 years
Account Debit Credit
Lease Incentive Liability 800
Rental Expense 800
  • The leasehold improvement needs to depreciate base on its useful life of 10 years. $ 10,000/10y = $ 1,000
Account Debit Credit
Depreciation Expense 1,000
Accumulated Depreciation 1,000

Record as Lessor Assets

The tenant improvement allowance is recorded as lessor assets if:

  • It is the lessor’s intention to improve the property.
  • The improvement increase assets future economic benefits
  • The lessor in charge of renovation and pay directly to the contractor

If the lessor owns the tenant improvement allowance, they simply record it as the fixed assets and depreciate over the useful life. There is no transaction record in the lessee’s book. All transactions will go through lessor book only.

Even the current lessee moves out, the lessor still owns the assets and the depreciation remains the same. The assets purely belong to the landlord. The fixed assets improvement will move from balance sheet to income statement through depreciation. It will be zero at the end of useful life.

Exception of Tenant Improvement Allowance

The tenant improvement allowance does not include the following items:

  • Furniture
  • Equipment
  • Logo
  • Moving Expense
  • Cable management