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Lease Accounting For Escalating Rent Payments

Lease accounting for escalating rent payments

Rent payments can be structured a variety of ways within a lease agreement, including fixed rent, rent escalations, percentage rent and based rent plus additional.

Fixed rent, which may also be referred to as a gross lease, is a monthly payment by the tenant that is often the easiest to account for.  Percentage rent is popular amongst retailers who want the property owner to be invested in their success, as the lease specifies rent as a percentage of gross sales against a base rent. The monthly rental amount stated in the lease is the base rent, and additional rent encompasses any charges specifically outlined in the lease, such as building repairs or fees related to late payments. 

Oftentimes, rent agreements classified as operating leases have uneven rent payment terms such as escalating rent payments.  For example, a 10-year building lease could specify a rent increase of 3 percent every year, after the first year, to help mitigate the negative effect of inflation and other costs that could negatively impact the lessor’s bottom line.

ASC 842 and IFRS 16 compliance elevates all operating leases from the footnotes and onto the balance sheet, necessitating capitalization of the present value of minimum lease payments as a liability and the capitalization of an asset for the “right to use.”

The way expenses will recognized under the new standard will be similar to the GAAP approach before compliance, with expenses recognized evenly across the term. Although for multi-national companies, it’s important to note the expense pattern will be front-loaded under IFRS.  The difference of the timing of expense recognition is the most significant divergence of the two boards. Learn more about CoStar’s calculation engine which is compliant with all FASB and IASB lease standards (ASC 840/FAS 13, ASC 842, IFRS 16), enables lease-by-lease analysis and classification and international currency conversion.