One of the most common types of lease incentive is where a landlord allows a business tenant a period of time rent free, often at the commencement of the lease. This is to incentivise the tenant to occupy the premises.
Typically, FRS 102 spreads the implicit gain (to the lessee) and the cost (to the landlord), arising from this rent free period, on a straight-line basis over the lease term and therefore as a reduction to the overall lease expense (FRS 102.20.15A). The treatment was different in old GAAP. The rent free period is known as a ‘lease incentive’ (as defined in the glossary of FRS 102).
Requirements
With any lease, it must be determined whether it is a finance lease or operating lease – the guidance for this assessment is detailed in FRS 102.20.5.
Assuming the lease is an operating lease (i.e. it does not transfer substantially all the risks and rewards incidental to ownership to the lessee), the lease payments must be recognised on a straight line basis over the lease term in accordance with FRS 102.20.15.
Exceptions to the straight line basis apply where another systematic basis is representative of the time pattern of the user’s benefit or the payments to the lessor are structured to increase in line with expected general inflation to compensate the lessor for their expected inflationary cost increases. These situations are not especially common.
There are other types of lease incentives which include; the landlord paying the cost of fitting out the tenant’s premises and/or paying the tenant’s legal fees associated with the lease agreement.
Example
A lessee enters a new ten year lease to rent a property. The first six months are rent free, and rent of €7,500 is payable quarterly thereafter.
In line with the above requirements, the lease payments will be recognised on a straight line basis over the lease term and the rent free period will be spread over the lease term as a reduction to the lease expense.
Lease expense
The total lease expense is:
€7,500 per quarter x 38 quarters = €285,000
The annual lease expense is therefore:
€285,000 / 10 years = €28,500 per year
Accounting entries
The accounting entries will therefore be as follows.
| Year 1 | Dr P&L expense (as above) | €28,500 | |
| Cr Cash (2 x €7,500) | €15,000 | ||
| Cr Accrual | €13,500 |
| Years 2-10 | Dr P&L expense (as above) | €28,500 | |
| Cr Cash (4 x €7,500) | €30,000 | ||
| Dr Accrual | €1,500 |
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- Reconciliation of net debt in statement of cash flows.
See also our new letter of representation for an audit client using IFRS – published on our website February 2020.
