Leasehold Improvement Journal Entry
Overview
Leasehold improvement is the amount that the company spends to enhance the rented building or office space. As the amount spent is usually material or significant, the company needs to properly make the journal entry for leasehold improvement by capitalizing the amount and amortize it over the useful life or the lease term.
Although the company does not own the leasehold building and the enhancement or improvement it paid for, it owns the right to use the building and the enhancement. This is why the company should capitalize the cost spent on the enhancement and recognize it as leasehold improvement on the balance sheet.
Leasehold improvement journal entry
The company can make the leasehold improvement journal entry by debiting the leasehold improvement account and crediting the cash account.
| Account | Debit | Credit |
|---|---|---|
| Leasehold improvement | 000 | |
| Cash | 000 |
In this journal entry, the leasehold improvement is an asset, in which its normal balance is on the debit side. The leasehold improvement is a type of fixed asset accounts where the company needs to amortize it over the useful life or the lease term.
Amortization of Leasehold Improvement
After recognizing the leasehold improvement as a fixed asset on the balance sheet, the company needs to amortize it over the useful life of the improvement if its useful life is shorter than the lease term. However, if the useful life of leasehold improvement is longer than the lease term, the lease term will be used as a base for amortization instead.
In short, whichever is shorter, either the useful life of the leasehold improvement or lease term, will be used as the base for the amortization of leasehold improvement. Though, in a rare case, when there is a high expectation of extending the lease period (with sufficient evidence) at the end of the lease term, the extended period will be added to the lease term when determining the amortization of the leasehold improvement.
The company can make the journal entry for the amortization of the leasehold improvement at the period-end adjusting entry by debiting the amortization expense account and crediting the accumulated amortization account.
| Account | Debit | Credit |
|---|---|---|
| Amortization expense | 000 | |
| Accumulated amortization | 000 |
Leasehold Improvement Example
For example, the company ABC enters a leasehold agreement with the landlord to rent the office space for five years. The company also spends $50,000 to make overall improvements on the building on several aspects such as the walls, the ceiling, and carpets, etc. The useful life of such improvement is expected to be 8 years.
In this case, the company ABC needs to recognize the $50,000 as a leasehold improvement and make the journal entry for leasehold improvement as below:
| Account | Debit | Credit |
|---|---|---|
| Leasehold improvement | 50,000 | |
| Cash | 50,000 |
As the lease term is shorter than the useful life of the leasehold improvement, the company ABC needs to amortize the $50,000 of leasehold improvement over the lease term which is 5 years.
Hence, the company ABC can make the journal entry for the amortization of the leasehold improvement on the first year as below:
| Account | Debit | Credit |
|---|---|---|
| Amortization expense | 10,000 | |
| Accumulated amortization | 10,000 |
It is useful to note that if the amount spent for enhancement or improvement of the lease is insignificant, the company can just directly record it as an expense instead of capitalizing it. For example, if the amount of leasehold improvement is less than the company’s capitalization limit, it can be recorded as an expense in the accounting period instead.