Rent Abatement and Rent-Free Period Accounting Under ASC 842

Questions this article answers

• Do I record lease expense during a rent-free period under ASC 842?
• How is the lease liability measured when the first months of a lease are free?
• Is a rent abatement from the landlord a lease modification under ASC 842?
• What happened to the deferred rent liability under ASC 842?

Rent abatement and rent-free period accounting under ASC 842 turns on one question: was the free rent in the lease at commencement, or granted later? Free months written into the original lease are part of the payment schedule. The liability is the present value of the payments actually due, and an operating lease's single straight-line cost spreads total payments across every month, free ones included. An abatement granted after commencement changes the consideration, and that is a lease modification.

Why do the free months still carry lease expense?

ASC 842-20-25-6(a) requires an operating lease lessee to recognize "a single lease cost, calculated so that the remaining cost of the lease ... is allocated over the remaining lease term on a straight-line basis." The paragraph allows another systematic and rational basis only where it better reflects the pattern of benefit.

Three free months do not change the pattern of benefit. The tenant occupies the space in month 1 exactly as it does in month 40. ASC 842-20-55-3 makes the point directly: lease cost "should not be affected by the extent to which the lessee uses the underlying asset."

So the income statement ignores the cash pattern. Total payments over the term, plus initial direct costs and less incentives, divide evenly by the number of months. Month 1 carries the same lease cost as month 60, even though no check is written until month 4.

The balance sheet does follow the cash pattern. ASC 842-10-30-5(a) defines lease payments as the fixed payments, including in substance fixed payments, less lease incentives paid or payable to the lessee. A month with no payment due contributes nothing to that list. The lease liability is therefore the present value of the 57 payments that exist, not 60.

How are the liability and right-of-use asset measured when the first three months are free?

At commencement, ASC 842-20-30-1 measures the lease liability at the present value of the lease payments not yet paid, discounted at the rate for the lease. The right-of-use (ROU) asset under ASC 842-20-30-5 is that liability plus initial direct costs and prepaid lease payments, less lease incentives received. With none of those extras, the ROU asset equals the liability on day one.

After commencement the two balances drift apart, and the free months are what pull them apart. ASC 842-20-35-3(a) keeps the operating lease liability at the present value of the remaining payments at the original rate. ASC 842-20-35-3(b) measures the ROU asset as that liability "adjusted for" prepaid or accrued lease payments, remaining lease incentives, unamortized initial direct costs and any impairment.

During a free month the lessee books $9,500 of cost and pays nothing. That $9,500 is an accrued lease payment. Under 842-20-35-3(b)(1) it reduces the ROU asset below the liability. Most systems get there by amortizing the ROU asset as a plug: straight-line cost less the interest accreted on the liability that month.

Worked schedule: a 5-year operating lease with 3 free months

Every input is stated so the arithmetic can be re-performed. A lessee signs a 60-month office lease. Rent is $10,000 per month, due on the first day of each month, with months 1 through 3 free. Payments run from the start of month 4 through the start of month 60: 57 payments, $570,000 in total.

The incremental borrowing rate is 6.0% per year, applied as 0.5% per month. There are no initial direct costs, incentives or prepayments, and the lease is classified as operating.

Straight-line lease cost is $570,000 divided by 60 months, or $9,500 per month and $114,000 per year. The lease liability at commencement is the present value of 57 payments of $10,000 at 0.5% per month, the first due three months after commencement: $489,990.89. The ROU asset starts at the same $489,990.89. Interest accretes each month on the balance after that month's payment.

Year	Cash paid	Straight-line lease cost	Interest accreted on liability	ROU asset amortization (cost less interest)	Lease liability, year end	ROU asset, year end	Liability less ROU asset
Commencement	$0	—	—	—	$489,990.89	$489,990.89	$0
1	$90,000	$114,000	$27,941.30	$86,058.70	$427,932.19	$403,932.19	$24,000.00
2	$120,000	$114,000	$22,421.52	$91,578.48	$330,353.71	$312,353.71	$18,000.00

Year 1 cash is nine payments of $10,000. Roll the liability forward: $489,990.89 plus $27,941.30 of interest less $90,000 paid equals $427,932.19. Roll the ROU asset forward: $489,990.89 less $86,058.70 of amortization equals $403,932.19. The $24,000 gap is cumulative cost ($114,000) less cumulative cash ($90,000), which under ASC 840 was the deferred rent liability.

Year 2 pays twelve months, so cash ($120,000) now exceeds cost ($114,000) and the gap shrinks by $6,000 to $18,000. It keeps shrinking by $6,000 a year and reaches zero at the end of year 5, when both balances reach zero. That unwinding is the free rent being "repaid" through the income statement.

What does the month-end entry look like in a free month and in a paying month?

Month 1 is a free month. Interest on the opening liability is $489,990.89 times 0.5%, or $2,449.95. The ROU amortization is the plug: $9,500.00 less $2,449.95, or $7,050.05.

• Debit operating lease cost $9,500.00
• Credit lease liability $2,449.95 (interest accretion)
• Credit ROU asset $7,050.05

No cash moves, and the liability grows. That is normal for a rent-free period and worth a note in the close file, because a growing lease liability looks wrong to anyone who has not seen the schedule.

Month 4 is the first paying month. The liability at the end of month 3 is $497,377.57. The $10,000 payment on day one reduces it to $487,377.57, and interest for the month is 0.5% of that, or $2,436.89. Amortization is $9,500.00 less $2,436.89, or $7,063.11.

• Debit lease liability $10,000.00, credit cash $10,000.00
• Debit operating lease cost $9,500.00
• Credit lease liability $2,436.89 (interest accretion)
• Credit ROU asset $7,063.11

Both months carry the same $9,500 on the income statement. Only the balance sheet movements differ. The commencement entry and the fuller set for both lease types are in operating and finance lease journal entries.

How does a finance lease treat the same rent-free period?

The liability is identical. Classification does not change the present value of the same 57 payments, so a finance lease also starts at $489,990.89 and accretes the same $27,941.30 of interest in year 1. What changes is the income statement. ASC 842-20-25-5(a) requires a finance lease lessee to recognize amortization of the ROU asset and interest on the lease liability as two separate amounts.

ASC 842-20-35-7 amortizes the ROU asset on a straight-line basis unless another systematic basis better reflects consumption. ASC 842-20-35-8 runs that amortization from the commencement date to the earlier of the asset's useful life or the end of the lease term.

Here that is 60 months: $489,990.89 divided by 60, or $8,166.51 per month and $97,998.18 per year. Add year 1 interest and total finance lease cost is $125,939.48, against $114,000 for the operating lease. Year 2 is $97,998.18 plus $22,421.52, or $120,419.70.

So a finance lease front-loads cost, and the free months are no exception. There is no straight-line plug and no accrued rent inside the asset. The free months carry amortization plus a full month of interest on a liability that nothing has reduced yet.

What changes when the landlord grants an abatement after commencement?

An abatement the original lease did not provide, such as three months forgiven during a downturn, is a change to the contract. ASC 842-10-25-8 treats a modification as a separate contract only when it grants an additional right of use at a commensurate price. Forgiving rent grants nothing new, so it is not a separate contract. The lessee then reassesses classification under ASC 842-10-25-9 as of the modification's effective date.

ASC 842-10-25-11(d) lists a modification that "changes the consideration in the contract only." For that case the lessee reallocates the remaining consideration. It remeasures the lease liability at a discount rate determined at the modification's effective date.

Under ASC 842-10-25-12 the change in the liability adjusts the ROU asset. No gain or loss hits the income statement, unless the reduction would take the ROU asset below zero; that case is covered below.

On the books, the liability falls by the present value of the forgiven payments at the new rate. The ROU asset falls by the same amount, and straight-line cost is recomputed prospectively over the remaining term.

The offset to the ROU asset stops at zero. If the reduction in the liability exceeds the remaining asset, ASC 842-20-35-4 recognizes the excess in profit or loss; KPMG's Handbook (paragraph 6.6.170) and Deloitte's Roadmap: Leases (section 8.6.3.6) both read it that way.

That applies to months not yet due. KPMG's Handbook, Question 6.7.08, treats past-due rent that is then forgiven as a lease incentive in accounting for the modified lease.

The abatement therefore reaches the income statement slowly, as lower cost in every remaining month, not as a windfall when granted. The lease modifications guide walks through the remeasurement mechanics and the documentation the file needs.

One edge case, and the first question to ask. Did the original lease already give the tenant an enforceable right to the abatement, say through a force majeure or casualty clause? If it did, and no other term affecting the scope of or consideration for the lease changes at the same time, granting the abatement is not a modification.

Exercising a clause of this kind is not one of the remeasurement events listed in ASC 842-10-35-4, so the lease liability and ROU asset are not remeasured.

KPMG's Handbook: Leases, Question 6.7.07, takes the position that the rent reduction is generally recognized as negative variable lease cost in the periods it relates to. That is the cost line ASC 842-20-25-6(b) provides for. If any other term changes alongside the concession, it is a modification after all. Read the clause, and the amendment, before choosing the path.

For concessions tied to the COVID-19 pandemic, the FASB staff issued a Q&A in April 2020. As reproduced on PwC Viewpoint, it let an entity elect to account for such concessions "as though enforceable rights and obligations for those concessions existed." The condition was that total payments stayed "substantially the same as or less than" under the original contract.

Applying modification accounting stayed permitted, not required. That relief was pandemic-specific; a 2026 abatement follows the normal modification path.

Where did the ASC 840 deferred rent liability go?

Under ASC 840 an operating lease stayed off the balance sheet, so the only trace of a rent-free period was the deferred rent liability. Straight-line expense exceeded cash during the free months, the excess accrued as deferred rent, and the balance unwound over the rest of the term. In the example above, that account would have shown $24,000 at the end of year 1 and $18,000 at the end of year 2.

ASC 842 keeps the same straight-line cost and the same accrued balance, but stops presenting it separately. ASC 842-20-35-3(b)(1) adjusts the ROU asset for "prepaid or accrued lease payments," so the $24,000 lives inside the asset as the difference between liability and ROU asset. Reconciling that difference to cumulative cost less cumulative cash is the fastest proof the schedule is right. The deferred rent guide covers the transition entries for balances open at adoption.

What does the auditor test on a rent-free period?

Expect four procedures. First, the auditor traces the free months and the payment due date to the lease abstract. A lease that says "rent commences on the 91st day" still starts straight-lining on the commencement date, not the first rent date. The Codification's glossary defines the commencement date as the date the lessor makes the asset available for use, so occupancy starts the clock.

ASC 842-10-55-25 is explicit: the lease term "begins at the commencement date and includes any rent-free periods provided to the lessee by the lessor."

The abstraction checklist in key real estate lease terms lists the fields to capture. Second, the auditor re-performs the present value from the stated inputs and expects $489,990.89, so payment timing (in advance or in arrears) must be documented. Third, they foot straight-line cost, cash and the liability-to-asset gap for the year. Fourth, for any abatement granted after commencement, they ask for the amendment, the modification date, the rate used and the recomputed straight-line cost.

If the lease also carries an index-linked escalation, the free months interact with it; the treatment of those increases is covered in accounting for future CPI increases under ASC 842. And where the free rent sits inside a service contract rather than a standalone lease, the free ASC 842 lease analyzer helps identify whether an embedded lease exists at all.

Frequently asked questions

Do the free months of a lease carry expense under ASC 842?

Yes for an operating lease. ASC 842-20-25-6 requires a single lease cost allocated over the lease term on a straight-line basis, so total payments are spread across every month, including the free ones. For a finance lease the free months carry amortization of the right-of-use asset plus interest on the liability under ASC 842-20-25-5.

Is a rent abatement granted after commencement a lease modification?

Usually. An abatement the original lease did not provide changes the consideration in the contract. Under ASC 842-10-25-11(d) the lessee remeasures the lease liability at an updated discount rate, and under ASC 842-10-25-12 the change adjusts the right-of-use asset. No gain or loss is recorded, unless the reduction exceeds the remaining right-of-use asset; ASC 842-20-35-4 then sends the excess to profit or loss.

Does deferred rent still exist under ASC 842?

Not as its own liability. The same accrued rent balance still builds during free months. ASC 842-20-35-3(b)(1) folds it into the right-of-use asset, which equals the lease liability adjusted for prepaid or accrued lease payments among other items. In the worked schedule the $24,000 gap between liability and asset at the end of year 1 is that balance.

Sources and further reading

• ASC 842-10-25-8 through 25-12 — separate-contract test, reassessment of classification, remeasurement at the modification date, ROU asset adjustment.
• ASC 842-10-30-5 — what lease payments consist of.
• ASC 842-10-35-4 — events that require a lessee to remeasure the lease payments.
• ASC 842-20-35-4 — a remeasurement that would take the right-of-use asset below zero is recognized in profit or loss.
• ASC 842-20-25-5 and 842-20-25-6 — finance lease cost and the operating lease single straight-line lease cost.
• ASC 842-20-30-1 and 842-20-30-5 — initial measurement of the lease liability and the ROU asset.
• ASC 842-20-35-3, 842-20-35-7 and 842-20-35-8 — subsequent measurement of the operating lease balances; amortization of a finance lease ROU asset and the period it runs over.
• ASC 842-10-55-25 — the lease term begins at the commencement date and includes rent-free periods.
• ASC 842-20-55-3 — lease cost is not affected by the extent of use.
• KPMG Handbook: Leases, Questions 6.7.07 and 6.7.08 — rent concessions, the enforceable-right test, negative variable lease cost, and forgiven past-due rent.
• PwC Leases guide, section 4.4, Subsequent recognition and measurement – lessee.
• Deloitte Roadmap: Leasing, section 8.6, Lease modifications.
• FASB Staff Q&A, Topic 842 and Topic 840: Accounting for Lease Concessions Related to the Effects of the COVID-19 Pandemic, as reproduced on PwC Viewpoint.

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