Rent Concessions in Commercial Leases: Types and How Each Is Accounted for Under ASC 842
Questions this article answers
- What is a rent concession in a commercial lease?
- Is a rent concession a lease incentive or a lease modification under ASC 842?
- How is a mid-term rent reduction recorded under ASC 842?
- How do I document a rent concession for the auditors?
A rent concession is any give-back a landlord grants on what a tenant would otherwise owe. It can be free rent, a lower rate, a deferral, a build-out allowance, a right to leave early, or a sweetener at renewal. ASC 842 has no category called "concession". Each one is either a lease incentive measured at commencement under 842-10-30-5 and 842-20-30-5, or a lease modification remeasured under 842-10-25-8 through 842-10-25-13.
Which of the two depends on when the concession was granted, and whether the original lease already provided for it.
When do landlords grant rent concessions?
Concessions cluster around three moments in a lease's life. The first is signing, when a landlord with vacant space offers free months or a build-out allowance to close the deal. The second is mid-term distress, when a tenant asks for relief because its business has changed. The third is renewal, when the tenant has leverage because moving is expensive for both sides.
When it was granted matters more to the books than how much it is worth. A concession written into the original lease is part of the lease payments. A concession agreed later, that the lease did not allow for, changes an existing contract. The auditor's first question is always which one you have.
Which concessions are incentives at commencement, and which are modifications?
Two paragraphs do most of the work. ASC 842-10-30-5 defines lease payments to include fixed payments "less any lease incentives paid or payable to the lessee". ASC 842-20-30-5 measures the right-of-use asset at commencement as the lease liability, plus payments made at or before commencement, "minus any lease incentives received", plus initial direct costs. Anything agreed after commencement goes through the modification guidance instead.
Free-rent periods
A free-rent period in the original lease is not a separate entry. It is a run of months in the schedule with a fixed payment of zero. ASC 842-10-55-25 states that the lease term "includes any rent-free periods provided to the lessee by the lessor," so the free months sit inside the schedule. The lease liability is the present value of the lease payments not yet paid under ASC 842-20-30-1(a), so free months lower it.
For an operating lease, ASC 842-20-25-6 requires a single lease cost. The remaining cost of the lease is allocated over the remaining lease term on a straight-line basis, unless another systematic and rational basis better represents the pattern of benefit. So the free months carry the same monthly cost as the paid ones.
Free rent granted after commencement depends on whether the lessee already had an enforceable right to it. If a force majeure clause or applicable law already entitled the tenant to the relief and nothing else in the contract changed, there is no modification.
KPMG's Handbook: Leases, Question 6.7.07, takes the position that such a reduction is generally accounted for as negative variable lease cost. If there was no such right, the concession changes the consideration in an existing contract and is a modification. Rent abatement and rent-free period accounting is a separate topic with its own full schedule.
Rent reductions
A permanent cut in the monthly rate, agreed mid-term, changes only the consideration. ASC 842-10-25-11(d) covers a modification that "changes the consideration in the contract only". The lessee remeasures the lease liability using a discount rate determined at the effective date of the modification. Under ASC 842-10-25-12, the change in the liability is recognized as an adjustment to the right-of-use asset.
Deloitte's Roadmap: Leases, section 8.6.3.6, notes that this kind of modification generally has no income statement effect. The example below shows why.
Rent deferrals
A deferral moves cash to later months without forgiving it. If the original lease has a clause that already permits the deferral, you apply the contract as written. If it does not, the deferral is a modification of the payment timing. It is remeasured under ASC 842-10-25-11, and the difference goes to the right-of-use asset under ASC 842-10-25-12.
There was one temporary exception. In April 2020 the FASB staff issued a Q&A on lease concessions related to the COVID-19 pandemic. It allowed entities to account for those concessions "as though enforceable rights and obligations for those concessions existed", without analyzing each contract. The election was available for concessions that do not result in a substantial increase in the rights of the lessor or the obligations of the lessee.
The Q&A gives the example of total payments under the modified contract being substantially the same as or less than under the original.
That was pandemic relief, not a general rule for deferrals. The site's COVID-19 lease accounting article covers that period.
Tenant improvement allowances
A tenant improvement allowance is the textbook lease incentive. If the landlord pays it at or before commencement, it reduces the right-of-use asset under ASC 842-20-30-5. If it is payable after commencement, it is an incentive "payable to the lessee" under ASC 842-10-30-5. It then reduces the lease payments that make up the liability.
Whether the improvements are the tenant's asset or the landlord's asset is a separate question, and it changes the entry. Tenant improvement allowance accounting is a separate topic, covered in depth on its own.
Early-termination rights
An option to leave early is not a payment; it changes the lease term. ASC 842-10-30-1 sets the lease term as the noncancelable period plus periods covered by a termination option the lessee is reasonably certain not to exercise. If you are reasonably certain to stay, the option changes nothing in the schedule. If the tenant later exits by agreement, ASC 842-10-25-11(c) treats it as a full or partial termination.
A termination is the concession most likely to hit the income statement, and the only one where ASC 842-10-25-13 requires a gain or loss by design. Under that paragraph, the right-of-use asset is reduced on a basis proportionate to the termination. Any difference between that reduction and the reduction in the lease liability is a gain or a loss. The modification accounting decision framework shows the arithmetic for a partial termination.
Concessions negotiated at renewal
Renewals bundle concessions: a few free months, a new allowance, a lower rate for the new term. If the renewal extends the lease by agreement, it is a modification under ASC 842-10-25-11(b), which covers a modification that "extends or reduces the term of an existing lease". It is a separate contract only if it meets both conditions in ASC 842-10-25-8. Those are an additional right of use, and payments that increase commensurate with the standalone price.
Either way, the free months and the allowance enter the remeasured consideration. An allowance still payable is a lease incentive payable to the lessee under ASC 842-10-30-5. It reduces the lease payments used in the remeasurement. Do not book it as income when the check arrives.
How does each rent concession affect the ROU asset and the lease liability?
This is the matrix a controller wants pinned above the desk. It assumes an operating lease and a tenant that is reasonably certain to stay for the noncancelable term. The last column is the document the auditor will ask for first.
| Concession | Typically granted | ASC 842 treatment | Lease liability | Right-of-use asset | Document the auditor asks for |
|---|---|---|---|---|---|
| Free-rent period, in the original lease | At signing | Fixed payments of zero in the schedule (842-10-30-5); straight-line cost (842-20-25-6) | Lower at commencement; no later adjustment | Equals liability plus prepaid, less incentives (842-20-30-5) | Executed lease with the rent schedule |
| Free-rent period, granted mid-term | Tenant distress | No modification if an enforceable right already existed and nothing else changed; otherwise a modification, consideration only (842-10-25-11(d)) | Unchanged if no modification; otherwise remeasured at the modification-date rate | Unchanged if no modification; otherwise adjusted by the same amount (842-10-25-12) | Signed amendment with effective date, or the clause or legal opinion supporting the enforceable right |
| Rent reduction | Tenant distress or market reset | Modification; consideration only (842-10-25-11(d)) | Remeasured down | Reduced by the same amount; no gain or loss unless the asset would fall below zero (842-20-35-4) | Signed amendment; discount-rate memo |
| Rent deferral | Cash-flow relief | Contract as written if a clause permits it; otherwise a modification (842-10-25-11) | Remeasured for the new timing | Adjusted by the same amount | Amendment, or the lease clause that allows it |
| Tenant improvement allowance | At signing or renewal | Lease incentive (842-10-30-5, 842-20-30-5) | Reduced if the allowance is payable after commencement | Reduced if received at or before commencement | Landlord's allowance letter; paid invoices |
| Early-termination right, not expected to be used | At signing | Lease term unchanged (842-10-30-1) | No effect | No effect | Reasonably-certain assessment memo |
| Early termination exercised or negotiated | Downsizing | Full or partial termination (842-10-25-11(c), 842-10-25-13; full termination, 842-20-40-1) | Remeasured or derecognized | Reduced proportionately; difference is a gain or loss | Termination agreement; proportion calculation |
| Renewal with free months or allowance | Renewal | Modification extending the term (842-10-25-11(b)) unless 842-10-25-8 is met | Remeasured over the new term, net of incentives payable | Adjusted by the same amount | Renewal amendment; classification reassessment (842-10-25-9) |
One row deserves a note. When a modification is not a separate contract, ASC 842-10-25-9 requires the lessee to reassess the classification of the lease. A renewal that adds years can push an operating lease across a classification line. The operating versus finance lease page lists the tests.
What does a mid-term rent reduction actually do to the books?
Here is the rent-reduction row with numbers. Every input is stated so the math can be checked.
- Operating lease, 36 months remaining, payments of $10,000 due at the end of each month.
- Discount rate at commencement: 6.00% per year, applied as 0.50% per month.
- The right-of-use asset equals the lease liability before the modification, so there is no accrued or prepaid straight-line balance.
- The landlord signs an amendment cutting rent to $9,000 per month for all 36 remaining months, effective at the start of the period.
- The discount rate determined at the modification date, as ASC 842-10-25-11 requires, is also 6.00%. This is an assumption; a different rate changes every figure below.
The present-value factor for 36 monthly payments at 0.50% is 32.871016. The liability before the amendment is $10,000 × 32.871016 = $328,710.16. The remeasured liability is $9,000 × 32.871016 = $295,839.14. The reduction is $32,871.02.
| Entry at the modification date | Debit | Credit |
|---|---|---|
| Operating lease liability | $32,871.02 | |
| Right-of-use asset | $32,871.02 |
Nothing touches the income statement in this example, because the right-of-use asset is large enough to absorb the whole reduction. Under ASC 842-10-25-12 the remeasurement goes to the right-of-use asset. With no straight-line balance outstanding, the monthly single lease cost drops from $10,000 to $9,000 for the remaining 36 months. Had the modification-date rate been above 6.00%, the liability would fall by more than $32,871.02, and the asset would fall with it.
The remeasurement triggers checklist lists when that rate is refreshed.
How do you negotiate and document a concession so the accounting holds up?
The negotiation and the documentation are the same task. The auditor needs to see an enforceable change, its effective date, and the consideration it changed. A handshake and a lower invoice are not a modification. They are a variance in the rent roll that nobody can explain.
A few habits keep concessions clean. Get every concession into a signed amendment, even a one-month deferral, with an effective date. State the concession in the lease's own units: a monthly amount, a number of months, or a dollar allowance, never "a discount". If it is an allowance, get the landlord's letter stating the amount and the conditions for payment.
The last habit is to record who approved the concession and when. A concession that is not enforceable against the landlord is not a change in lease payments. The lease modification documentation article lists what to capture and how long to keep it.
When the concession arrives at signing, ask for it as a rent schedule rather than a side letter. A schedule with zero months is clear. A side letter promising "three months free at some point" leaves the liability open to argument.
What does the controller record after a concession?
For a concession in the original lease, there is nothing new to record at month-end. The schedule already reflects it. The single lease cost is straight-line under ASC 842-20-25-6, and the liability unwinds on the payments actually due. A free month shows as expense with no cash, and the straight-line balance absorbs the difference.
For a concession after commencement, the month-end work has three steps. Book the remeasurement entry at the modification date. Replace the amortization schedule from that date forward with the remeasured liability and the updated rate. Recompute the straight-line cost over the remaining term, because the remaining cost of the lease has changed.
For a termination, add a fourth step. A full termination derecognizes the entire right-of-use asset and lease liability under ASC 842-20-40-1, with the difference to gain or loss. A partial termination reduces the right-of-use asset proportionately under ASC 842-10-25-13; compute that reduction and post the gain or loss.
Keep the proportion calculation with the termination agreement, because it is the first thing the auditor will tie out. The journal entries article shows the recurring entries, and the modifications and remeasurement guide covers the mechanics in more depth.
Frequently asked questions
Is a rent concession a lease incentive or a lease modification?
It depends on when it was granted. A concession written into the original lease, such as a free-rent period or a tenant improvement allowance, is part of the lease payments and the right-of-use asset at commencement. The paragraphs are ASC 842-10-30-5 and 842-20-30-5. A concession agreed after commencement that the lease did not already provide for is a lease modification under ASC 842-10-25-8 through 25-13.
Does a rent reduction create a gain on the income statement?
Not by itself. A modification that only changes the consideration is remeasured under ASC 842-10-25-11. The change in the lease liability is booked as an adjustment to the right-of-use asset under ASC 842-10-25-12. A gain or loss arises by design only when the modification fully or partially terminates the lease, under ASC 842-10-25-13.
There is one other case. If the reduction in the lease liability is larger than the remaining carrying amount of the right-of-use asset, the asset cannot go below zero. The excess is recognized in profit or loss (ASC 842-20-35-4; Deloitte Roadmap: Leases, section 8.6.3.6).
Does a free-rent month mean zero lease expense that month?
No, for an operating lease. ASC 842-20-25-6 requires a single lease cost, with the remaining cost of the lease allocated over the remaining lease term on a straight-line basis unless another systematic and rational basis better represents the pattern of benefit. So the free months carry the same monthly cost as the paid months. The cash saving shows up as a lower lease liability, not as a month with no expense.
Sources and further reading
- ASC 842-10-30-5 — lease payments, net of lease incentives paid or payable to the lessee.
- ASC 842-20-30-5 — initial measurement of the right-of-use asset.
- ASC 842-20-25-6 — single straight-line lease cost for an operating lease.
- ASC 842-10-30-1 — the lease term, including periods covered by termination options.
- ASC 842-10-25-8 and 842-10-25-9 — separate-contract test; classification reassessment.
- ASC 842-10-25-11 through 842-10-25-13 — remeasurement, the right-of-use asset adjustment, and terminations.
- ASC 842-10-55-25 — the lease term includes rent-free periods provided by the lessor.
- ASC 842-20-30-1 — the lease liability at the present value of the lease payments not yet paid.
- ASC 842-20-35-4 — a remeasurement that would take the right-of-use asset below zero is recognized in profit or loss.
- ASC 842-20-40-1 — accounting for a full termination before the end of the lease term.
- KPMG Handbook: Leases, Question 6.7.07, Rent concessions — the enforceable-right test and negative variable lease cost.
- PwC Leases guide, section 4.2, Initial recognition and measurement – lessee.
- PwC Leases guide, section 5.2, Accounting for a lease modification – lessee.
- Deloitte Roadmap: Leases, section 8.4, Recognition and measurement.
- Deloitte Roadmap: Leases, 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 (April 2020), as reproduced on PwC Viewpoint.
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