By incentive in rental relationships, we mean discounted rent or free rent. Rental incentives are mainly found in long-term contracts of lease. A landlord, who is trying to secure a long-term lease and thereby secure a long-term income, is willing to offer discounts and bonuses to convince the tenant of the benefits of the lease. The most common form of incentive is “rent free”. 

Rent free allows the tenant to use the leased premises for a certain period of time with reduced or even zero rent. This benefit may be short-term, but it may also influence the entire tenancy. It is assumed that the rent saved in the first years of the lease is essentially carried over to subsequent years. This means that the tenant will pay the value, but not at present, because the rent payment is deferred into the future and will only be paid when the benefit ends.

Other types of incentives include reimbursement of the costs of moving to the newly rented space or, for example, covering severance payments from the original lease. 

National Accounting Council (“NAC”) Interpretation I-17 Incentives in Lease Relationships addresses whether an incentive will be accrued in the accounting.

Interpretation of the NAC

The Interpretation asks whether the benefits provided by the lessor are to be accrued or whether they have a one-off effect on profit or loss when they are provided.

From the perspective of both the lessor (service provider) and the lessee (customer), it must be assessed whether the advantage is aimed at attracting or retaining a new lessee. Only in such cases can the benefit be called an incentive and can be accrued. In the accounting, an incentive is accrued over the total term of the lease.

However, it is not an incentive, if the landlord provides a discount on the rent, e.g. due to reconstruction of the building or due to making it impossible to use the leased premises in full, etc.

Accounting for rent free in Czech accounting regulations

Lessor

The lease gives the entity income on the one hand and a receivable on the other. However, in the case of a rental incentive, the landlord also has a future claim for the reduced rent. This is represented by account 385 – Accrued income. The income remains on the balance sheet because the income falls within the time period, but the receipt of money has not yet occurred. Thus, the lessor recognises the invoice receivable and the revenue in the form of revenue from the sale of services, as well as a future entitlement in the form of deferred income together with the revenue in the form of revenue from the sale of services.

Lessee

For the tenant, on the other hand, the rent is an expense incurred in the business and, on the other hand, an obligation he is obliged to pay. Similarly to the landlord, the tenant is not obliged to pay rent in the current period in the case of an incentive. However, the lessee is able to say with certainty that it will have to pay this value in the future and thus predicts the value of the liability expressed in account 383 – Accrued expenses. In this case, the cost is materially and temporally related to the current period, but the expenditure of money occurs only in the future. Thus, the lessee recognizes the cost of services consumed and a liability under the invoice, as well as the cost of services consumed and a future obligation to pay that cost as an accrued expense.

Let’s take a look at a practical example.

Example of accounting for an incentive in 5-year leases from the lessee’s perspective

The tenant has a 5-year contract, with the amount of rent in each year shown in the table below. The tenant should thus calculate the value of the entire 5-year lease and calculate the average annual rent amount. In our case, the average annual rent will reach 310.

Although the lessee will account for the reduced rent of 100 in the first year according to the invoice, he will also account for the cost and the related future obligation to pay the average rent in account 383 Accrued expenses through an internal document. This will continue for the next two years. 

In the fourth year, when the invoiced rent is higher than the calculated average rent, Account 383 Accrued expenses will gradually be cleared, thereby reducing the rent expense in that year to the average rent amount.

The effect of the entire accounting treatment is then that the lessee’s accounts will not show fluctuations that do not arise from the inherent nature of the economic activity. The actual accounting treatment in each year is stated below.

Similarly, the lessor will record this rental relationship in his accounting, i.e. it will use the “accrued income” account to ensure regularity in reporting the value of rental income. 

Conclusion

If you, too, find yourselves in a situation, where you are holding a new lease agreement, where the rent is not set at one regular amount, and you do not know how to enter it in the accounting, we will be happy to help you with the situation.