How Do You Account For Leasehold Improvements
Leasehold improvements refer to alterations made to rental property to customize it for the specific needs of a tenant. Like other long-term assets, leasehold improvements are capitalized, which means they are recorded as an asset on the balance sheet and then depreciated over the shorter of their useful life or the remaining lease term.
When a company incurs costs for leasehold improvements, these costs are initially recorded as a long-term asset. The journal entry is as follows:
Debit: Leasehold Improvements (Asset)
Credit: Cash or Accounts Payable
Over time, the leasehold improvements are depreciated and the annual depreciation expense is recorded on the income statement. The journal entry for recording depreciation is as follows:
Debit: Depreciation Expense
Credit: Accumulated Depreciation – Leasehold Improvements
Here’s a simplified example:
XYZ Corp. signs a lease for a new office space and spends $50,000 on leasehold improvements. The lease term is 10 years, and XYZ Corp. estimates that the useful life of the improvements is 10 years. The initial entry when the improvements are made would be:
Debit: Leasehold Improvements $50,000
Credit: Cash $50,000
Then, each year, XYZ Corp. would record $5,000 in depreciation expense ($50,000 / 10 years):
Debit: Depreciation Expense $5,000
Credit: Accumulated Depreciation – Leasehold Improvements $5,000
By the end of the lease term, the total accumulated depreciation will equal the initial cost of the leasehold improvements, and the net book value of the Leasehold Improvements will be zero.
Please note that changes in accounting rules can affect the accounting for leasehold improvements. Always consult with an accounting professional to ensure that you’re following the most current standards.
Example of How to Account For Leasehold Improvements
Let’s say a restaurant, Yummy Burgers Inc., leases a building for 10 years. They decide to spend $100,000 on leasehold improvements to tailor the interior to their needs. This includes additions such as specialized kitchen equipment, customized seating, and interior décor.
Here’s how they would account for these leasehold improvements:
1. Recording the Leasehold Improvements:
When the improvements are made, they are initially recorded as a long-term asset. The journal entry would be:
Debit: Leasehold Improvements $100,000
Credit: Cash $100,000
This reflects that $100,000 has been spent on leasehold improvements, reducing the cash by the same amount.
2. Depreciating the Leasehold Improvements:
Assuming that Yummy Burgers Inc. will use the straight-line method of depreciation, and the improvements are estimated to have a useful life equal to the length of the lease (10 years), the annual depreciation expense would be $10,000 ($100,000 cost / 10 years).
Each year, Yummy Burgers Inc. would make the following entry to record the depreciation expense:
Debit: Depreciation Expense $10,000
Credit: Accumulated Depreciation – Leasehold Improvements $10,000
This shows that $10,000 worth of value has been used up over the course of each year.
By the end of the lease, the total depreciation would amount to $100,000, which equals the initial cost of the leasehold improvements. At that point, the net book value of the Leasehold Improvements (Cost – Accumulated Depreciation) would be $0.
This is a simplified example, and actual situations could have additional complexities. For instance, if the lease contains renewal periods and it is reasonably certain that the lease will be renewed, the life of the improvements could potentially be extended. Always consult with an accounting professional to ensure accurate accounting treatment.
