Quite often rent agreements classified as operating leases include uneven rent payment terms (e.g., escalating rent payments or rent holidays). For example, a 5-year building rent agreement may specify that rents will go up 5% every year after the first year. Some companies assume that the rent expense should be recognized based on the rent payments. However, under US GAAP this most probably won’t be true. In this article, we review accounting for lease agreements with uneven rent payments.

1. Accounting guidance on escalating rent payments or rent holidays

Accounting standards (US GAAP) indicate that rent should be recognized as expense over the lease term as it becomes payable. However, if rent payments are not made on a straight-line basis, rent expense still needs to be recognized on a straight-line basis. There is an exception to this rule: if another systematic and rational basis is more representative of the time pattern in which use benefit is derived from the leased property, that basis shall be used.

This “straight-lining” provision may be applicable to agreements where there are escalating rent payments or rent holidays.

The formula to calculate the monthly rent expense when rent payments are not made on a straight-line basis is as follows:

Differences between monthly rent expenses and rent payments are known as deferred rents. Deferred rents are recorded in either an asset account (e.g., other current or noncurrent assets) when the cumulative difference between rent expenses and rent payments as of a balance sheet date is negative or a liability account (e.g., other current or noncurrent liabilities) when the cumulative difference is positive. The balance in a deferred rent account normally increases, reaches its highest point and then gradually decreases as the lease term approaches its end.

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