What Happened to Deferred Rent under ASC 842?

You may find yourself asking, “Where did deferred rent go? How do I account for operating leases under the new lease accounting standards?” This article will explain how deferred rent was recorded for operating leases under ASC 840 and how to properly account for operating leases under ASC 842. 

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Deferred Rent Under ASC 840: 

Under ASC 840, for operating leases, deferred rent was used to record the difference between the monthly lease expense (sum of payments throughout lease divided by lease term) and monthly lease payments: 

Lease expense - lease payment = deferred rent

Deferred rent, a liability, increases with a credit and always reduces to a zero balance at the end of the lease. As noted above, deferred rent exists when the monthly lease expense varies from the lease payment. This difference can be caused by an abatement period, initial direct costs, rent increases, prepaid expenses or lease incentives. If none of these are present in the lease, the monthly lease expense will equal the lease payment, and deferred rent will not be recorded.

Example 1 

As seen in the schedule below, this lease contains a three-month abatement period during which the lessee is not required to make lease payments. 

undefined-Dec-22-2022-03-31-04-6858-PM

During this abatement period, deferred rent will increase each month by the amount that the lease expense exceeds the lease payment. 

undefined-Dec-22-2022-03-31-12-2447-PM

Once the abatement period ends, monthly payments will exceed the monthly lease expense. This will reduce the deferred rent balance each month until it reaches zero at the end of the lease. 

Deferred Rent Under ASC 842: 

Under the new guidance in ASC 842, for operating leases, deferred rent is no longer recorded. In its place, Right-of-Use (ROU) Asset and Lease Liability are recorded. Each is reduced in subsequent periods, ending in zero balances at the end of the lease. 

The Lease Liability represents the present value of the lessee’s obligations under the terms of the lease (ASC 842-20-30-1). 

The ROU Asset represents the lessee’s right to use the leased asset. It is calculated as the sum of the lease liability, prepaid lease payments and initial direct costs minus any lease incentives (ASC 842-20-30-5). 

Example 2: 

As seen in the schedule below, this is the same lease as Example 1. Additional details, such as incremental borrowing rate and prepaid lease payments, have been added to support necessary calculations. 

undefined-Dec-22-2022-03-33-50-4117-PM

An initial entry records the ROU Asset and Lease Liability: 

undefined-Dec-21-2022-11-27-39-4117-PM

In subsequent months, the difference between the lease expense and lease payments will be recorded as adjustments to the ROU Asset and Lease Liability rather than deferred rent. 

 undefined-Dec-21-2022-11-28-08-0925-PM

For certain short-term, low-value leases, companies may elect a short-term lease exemption and account for the lease in a manner similar to ASC 840 (including use of deferred rent).

NetLease Makes Operating Leases Easy: 

Accounting for operating leases under ASC 842 involves building out schedules to calculate and track items such as interest accretion and ROU asset balances. NetLease by Netgain automates these schedules.  

Operating schedule in NetLease

NetLease also automates monthly amortization journal entries as well as entries to transition from ASC 840 to ASC 842. 

Bottom Line: 

Deferred rent is replaced by an ROU Asset and Lease Liability under ASC 842. Accounting for the transition from ASC 840 to ASC 842 can be complex and time-consuming. NetLease by Netgain can simplify the process by automating your amortization and reclassification entries, billing and lease calculations to ensure you are GAAP compliant. 

It's easier with NetLease

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