Accounting for Lease Incentives and Rent Holidays under ASC 842

✦ Lease incentives and rent holidays reduce a lessee’s net lease cost and must be accounted for by adjusting the right-of-use (ROU) asset and lease liability.

✦ Under ASC 842, these incentives are accounted for as a reduction of lease payments used to calculate the lease liability.

✦ Rent-free periods are not excluded from lease term but result in a lower straight-line lease expense over the full term.

✦ Accurate treatment ensures consistent expense recognition and proper measurement of the ROU asset.

1. What Are Lease Incentives and Rent Holidays?

✦ Lease incentives are payments or concessions provided by the lessor to the lessee.

✦ Examples include:

 • Upfront cash payments or reimbursements for improvements

 • Free or reduced rent for initial periods (rent holidays)

 • Lessor’s payment of relocation or moving costs

✦ These affect the initial measurement of the lease under ASC 842.

2. Initial Measurement — Incentives Reduce Lease Payments

✦ Incentives reduce the total lease payments used to compute:

 • Lease liability (present value of future lease payments)

 • ROU asset (initial measurement includes adjusted lease liability)

✦ The reduction applies even if the payment is made directly to a third party on the lessee’s behalf.

Example:

• Total contractual rent = $120,000 over 3 years

• Incentive: $6,000 tenant improvement reimbursement

→ Net lease payments = $114,000

3. Accounting for Rent Holidays

✦ Rent holidays are included in the lease term and treated as part of the fixed consideration.

✦ Lessee must recognize straight-line lease expense over the lease term, including the rent-free period.

Example:

• 3-year lease with 6-month rent holiday

• Monthly rent after holiday = $5,000

→ Total rent over 36 months = $150,000 (excluding free months)

→ Straight-line monthly expense = $4,167

4. Journal Entry — Lease Commencement with Incentive

Assumptions:

• Lease liability = $100,000

• Incentive = $10,000 cash from lessor

→ ROU asset = $90,000

Entry:

debit ROU Asset – $90,000

 credit Lease Liability – $100,000

 debit Cash – $10,000

5. Subsequent Lease Expense Recognition

✦ Lessees under operating leases recognize:

 • Single lease expense on a straight-line basis

 • No separate interest and amortization components

✦ Expense includes effect of incentives and rent holidays over the full lease term.

Entry (monthly):

debit Lease Expense – $X

 credit Lease Liability – $Y

 credit ROU Asset – $Z

6. IFRS Comparison (IFRS 16)

Topic	US GAAP (ASC 842)	IFRS 16
Incentive treatment	Reduces lease payments	Same
Rent holidays	Included in lease term	Same
Expense recognition	Straight-line (operating leases)	Same (single lease model)
Disclosure requirements	Detailed for ROU and liabilities	Similar

7. Disclosure Requirements

✦ Disclose:

 • Nature and amount of lease incentives received

 • Terms of rent holidays or concessions

 • Impact on lease liability and ROU asset

 • Total lease expense for the period

✦ Ensure consistency with lease term and payment schedule shown in footnotes.

8. Common Errors

✦ Excluding rent-free periods from lease term calculation

✦ Failing to net incentives against total lease payments

✦ Recognizing lease expense unevenly instead of straight-line

✦ Omitting disclosure of material incentives or concessions

✦ Misclassifying cash reimbursements as income instead of ROU asset adjustments