Leasehold is an arrangement in which the owner of the property, also known as landlord leases out his property to another party for use for a fixed period of time. The person who takes the property on the lease (lessee) will have the legal agreement with the landlord (lessorLessorA lessor is an individual who legally owns the asset granted on a lease (rented for a long tenure) to the lessee who pays a single lump sum amount or regular payments for using that asset.), also called Lease agreement.
The lease agreement specifies the period of the lease, amount to be paid every month, increase percentage annually, or as agreed and maintenance cost if there is any. In most cases, the Leasehold property is a real estate asset that is taken on lease for a fixed period.
Leasehold Contract Example – Rent Journal Entry
The person who takes the property has to pay a monthly lease rental, and if the Landlord has agreed to maintain the property, in that case, the maintenance amount also has to be paid to the Landlord. The maintenance included security at the entrance, cleaning of common areas and parking, maintenance of lift and other facilities like CCTV, lighting in common areas, etc.
The monthly charge paid is considered as rent and accounted for in the books as operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.. So, the following journals entries will be posted in the books when rent is paid to a landlord –
When the rent becomes due –
|To Landlord A/C||XXX|
|Profit & Loss A/C||XXX|
|To Rent A/C||XXX|
When the rent is paid –
|To Bank A/C||XXX|
Leasehold Improvement Journal Entry Example:
Leasehold arrangements usually consist of a real estate asset, and the period is for a longer period of time, usually from 5-99 years, however, it may vary as per agreement between the parties. A person or an organization takes the property on lease for a specific purpose, and most of the time, the asset is not in the required state, so the tenant has to spend a good amount of money to bring it in the desired state.
For example, let’s say X Ltd. has taken a building on lease for 15 years, and it is the business of IT consulting. The building will not have the desired number of cubicles to sit for employees or the number of meetings rooms X Ltd. is looking for. In this case, X Ltd. gets the interior done for the building, which includes making cubicles for employees, meeting rooms, wiring, carpet work, painting, fencing, etc.
If we assume that X Ltd. has spent $500,000 for the whole work, this whole expense is considered as Leasehold Improvement. Now X Ltd. is not supposed to expense out $500,000 in one financial year, as this amount has to be spread over the life of the lease. In this case, as the lease period is 15 years, the Improvement amount of $500,000 has to be amortized over 15 years equally, i.e., $33,333 per year. Journals in this case –
When the amount is expensed –
When the Leasehold Improvement amount is amortized annually –
1st Year –
The journal entries for amortization remains the same from year 1 to 15. The accumulated amortization balance will increase every year by $33,333 and by the end of 15th year, accumulated amortization balance will be $500,000 which means that cost of improvement $500,000 would be amortized fully and Leasehold improvement balance of $500,000 will be nullified by the accumulated amortizationThe Accumulated AmortizationAccumulated amortization is an aggregated value of the amortization expense that has been recorded for an intangible asset based on the cost, lifetime and usefulness that has been allocated to the asset in producing the units. of $500,000 and net book value would be zero.
- Leasehold arrangement saved a person or a business entity from the initial huge capital expenditureCapital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.
- The Landlord gets the rental benefit while the tenant enjoys the right to use the property for a specified period.
- The tenant also gets the tax benefitTax BenefitTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place. on the rental expense, and maintenance amount paid periodically.
- One of the best options available to businesses;
- Both the parties have legal rights to opt-out of arrangement in case of default from either party on agreed terms and conditions.
- The property at the end of the lease period goes back to the Landlord.
- The tenants usually complain about negligence from Landlord regarding common area maintenance and other arrangements.
- The Leasehold rentals sometimes are too high.
- Many experts consider Freehold properties to be better.
Points to Note about Changes
In most countries, there is a separate accounting standard for Leasehold accounting, which needs certain disclosure from both parties, which should be done promptly to avoid penalties. Also, while paying the rent to a landlord, the tenant is supposed to deduct a certain amount called Tax deducted at source and submit it to the Tax authorities.
Leasehold properties, if utilized tactically and carefully, will reap great benefits for any person or business. In a practical world, when a business starts doing well, the Landlord sometimes wants to take back the place and will go to some extent to opt-out of the agreement.
Any business or person must consider all these things before getting into any long terms of Leasehold commitment. If they can take care of these things carefully documented in the agreement, it will only be beneficial for the business, in the long run, that is why Leasehold arrangement is one of the most prevalent arrangements available to organizations in the market.
This article has been a guide to what is Leasehold, and it’s meaning. Here we discuss the examples of leasehold journal entries along with its advantages and disadvantages. You can learn more from the following articles –