The Lease Puzzle: Accounting For Tenant Improvement Allowances Not Paid Upfront

May 14, 2025

Tenant Improvement Allowances: Understand Your Options

As your business enters into leases for new restaurant spaces, one common lease incentive you will encounter is the tenant improvement allowance (TIA) — a provision in which the landlord agrees to reimburse the tenant for all or a portion of the costs incurred to customize or build out the leased space to meet the tenant’s specific operational needs. Tenant improvement allowances that are neither paid nor payable at the time of lease commencement present a unique accounting challenge for lessees, as there is no explicit guidance on recognition in accordance with ASC 842 Leases.

The lessee has three primary options for accounting for these allowances, which can significantly affect the initial measurement of the right-of-use asset and lease liability as well as the lease expense over time. Let’s explore the three primary options available to lessees when accounting for such allowances and the one we recommend based on GBQ’s interpretation of best practices under ASC 842.

1. Initial consideration

If a lease specifies a maximum reimbursement and the lessee will incur costs equal to or exceeding this amount, the lessor is deemed to pay it at the commencement date. This full amount is considered at lease commencement and is recognized as a reduction in the right-of-use asset and lease liability. The offset to lease liability amounts to being the TIA receivable, and once cash is received, the lease liability is then credited. When setting up the lease accounting, you would estimate when the cash proceeds will be received. This option is more in line with previous tenant improvement accounting, where the tenant improvement allowance reduces the rent expense over the entire term of the lease.

2. Prospective recognition upon qualification of reimbursement

When a lessee incurs costs that qualify for reimbursement by the lessor, the lessee reduces the right-of-use asset and lease liability by the amount of the costs. The reduction to the right-of-use asset is recognized prospectively over the remaining lease term.

3. Catch-up adjustment upon qualification of reimbursement

When a lessee incurs reimbursable costs, they reduce the right-of-use asset and lease liability by those costs. This reduction is recognized as a cumulative adjustment to expense, as if the incentive was provided at the start of the lease.

In the absence of clear-cut guidance under ASC 842, lessees must carefully assess the facts and circumstances surrounding tenant improvement allowances that are not paid or payable at lease commencement. While each of the three options presented offers a valid accounting approach, GBQ recommends the first approach of initial consideration, which allows for greater consistency in lease classification and a more accurate reflection of the lease expense in the financial statements.

To make sense of this under option 1, please see below:

Day 1 lease set up
- Record the tenant improvement allowance receivable as a debit to Lease Obligation and a credit to Right of Use (ROU) Asset.
- Estimate when the TIA will be paid in cash and record in the expected month of your lease accounting software or spreadsheet. This will result in a credit to the Lease Obligation and the debit being the cash received. There is no impact on the ROU asset as the TIA is being accreted against the straight-line amortization of the ROU asset.
Date tenant improvement allowance is paid in cash
- Revisit your assumption of when cash is received. If you are within a few months of your original estimate, a revision is likely not necessary. If this impacts year-end reporting by falling into a different year than originally estimated, consider performing a revision of the lease to account for the TIA payment in the proper year.

Based on experience, it is difficult to rationalize how the “TI receivable” is recorded as an offset to the lease obligation and for tracking purposes. Once the month comes when you should have received the TI allowance payment, you will quickly see that your lease accounting does not reconcile, and follow up with the lessor is needed to obtain payment if not received already.

Incorporating the allowance into the initial measurement of lease assets and liabilities ensures a smoother recognition of lease expense and avoids later adjustments that could complicate financial reporting. Properly securing and recognizing lease incentives, such as tenant improvement allowances, not only provides significant financial benefits to businesses by reducing upfront costs but also ensures accurate financial reporting and compliance with ASC 842.

If you have any questions, please reach out to Laura Wilhelm, CPA or the GBQ restaurant services team.

By Laura Wilhelm, CPA, Assurance & Business Advisory Services