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Australian Government
Department of Finance and Administration
Accounting Guidance Note
No. 2007/3
Accounting guidance notes are intended for use by Australian Government reporting entities
covered by:

S49 of the Financial Management and Accountability Act 1997; or

Clause 2 of Schedule 1, of the Commonwealth Authorities and Companies Act 1997.
The aim of the accounting guidance notes is to provide non-mandatory explanation and examples
relating to the interpretation and application of Australian Accounting Standards and the Finance
Minister’s Orders to the above entities.
Accounting for Lease Incentives
Purpose
To provide guidance on the accounting for lease incentives by the lessee.
Target audience
This guidance note applies to Australian Government entities in receipt of lease
incentives provided as an inducement to enter into an operating lease. Finance leases
are excluded from the scope of this guidance.
Applicable accounting pronouncements

Interpretation 115 Operating Leases – Incentives.

AASB 117 Leases.
Definitions used

Lease incentives are benefits offered by the lessor to induce another party to
enter into, or renew an operating lease. Examples include:

rent free periods (or reduced rentals);

upfront cash payment to the lessee (including the assumption of costs); and

capital incentives in the form of assumption of costs by the lessor (i.e.
relocation costs, leasehold improvements, and costs associated with preexisting lease commitment of the lessee).
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Accounting Guidance Note 2007/3
Department of Finance and Administration
Key points
1.
Lease incentives received are recognised as a reduction of rental expense over
the lease term on a straight-line basis unless another systematic basis is more
reflective of the time pattern of the lessee’s benefit (Interpretation 115.5).
2.
A straight-line basis is appropriate when the benefits received are expected to
be spread evenly over the lease term. For example, a property lease where the same
building is leased over several years.
3.
Where the benefits are not spread evenly an alternative method that
appropriately reflects this pattern should be used. For example where the benefit is
based upon output from machines, an approach such as recognition based upon
machine hours would be appropriate.
Disclosure requirements
4.
There are no specific disclosure requirements for lease incentives in
AASB 117 and Interpretation 115.
Illustrative examples
Illustrative example 1 – Rent free periods
Information:
A rent free period of one year is received on a five year lease, with an annual rental of
$25,000 per year.
Answer:
The value of incentive is obtained by dividing the total minimum lease payments to be
made under the lease by the lease term or ((25,000 x 4)/5 = $20,000).
The entity will initially recognise a liability and a matching asset, over the rent free
period the asset is expensed as the rent free period is utilised.
Debit
Credit
Year 0 (lease inception)
Lease asset (rent free period)
20,000
Lease incentive liability
20,000
Year 1
Lease expense
Lease asset (rent free period)
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20,000
20,000
Accounting Guidance Note 2007/3
Department of Finance and Administration
Debit
Credit
Year 2 to 5 (this journal is repeated)
Lease expense
20,000
Lease incentive liability
5,000
Cash
25,000
The effect of the above journals is that $20,000 is recognised as a lease expense in
each period.
Note - In practice, entities might not recognise a lease asset for the rent free period.
Instead, these entities build up their lease incentive liability each month as they
recognise the lease expense during the rent free period. In the above example this
would result in the transactions reported in Year 0 and 1 being replaced by a monthly
journal of debit lease expense $1,666.67 and credit lease incentive liability $1,666.67.
Illustrative example 2 - Upfront cash payment to the lessee
Information:
The lessee receives an upfront cash payment of $2,400 to enter into a new lease. The
new lease has a term of 3 years and an annual rental of $26,000 per year.
Answer:
The liability (incentive) is recognised as a reduction in lease expense over the life of
the lease.
Debit
Credit
Year 0 (lease inception)
Cash
2,400
Lease incentive liability
2,400
Year 1 to 3 (this journal is repeated)
Lease expense (26,000 – 2,400/3)
25,200
Lease incentive liability (2,400/3)
800
Cash
26,000
Illustrative example 3 - Units of production method – expected use
Information:
The lessee receives an upfront cash payment of $10,000 to enter a 2 year lease with an
annual rent of $40,000 for machinery. The machinery can only be used for 30,000
hours in year 1 and only 10,000 hours in year 2 due to maintenance (total hours =
40,000)
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Accounting Guidance Note 2007/3
Department of Finance and Administration
Answer:
In this example the rental expense under AASB 117 and the lease incentive are not
recognised on a straight line basis, as the expected benefit from the asset varies not in
accordance with time (year one: ¾ of the benefit, year two: ¼ of the benefit).
The rent expense and reduction of the lease incentive are recognised on the basis of
the benefit. To illustrate this, the transaction has been separated into two journals.
Rent expense
Reduction of lease incentive
Year 1
¾ x 80,000 = 60,000
¾ x 10,000 = 7,500
Year 2
¼ x 80,000 = 20,000
¼ x 10,000 = 2,500
Debit
Credit
Year 0 (lease inception)
Cash
10,000
Lease incentive liability
10,000
Year 1
Lease expense journal
Lease expense
60,000
Rent payable liability (future period)
20,000
Cash
40,000
Lease incentive journal
Lease incentive liability
7,500
Lease expense
7,500
Year 2
Lease expense journal
Lease expense
20,000
Rent payable liability (future period)
20,000
Cash
40,000
Lease incentive journal
Lease incentive liability
Lease expense
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2,500
2,500
Accounting Guidance Note 2007/3
Department of Finance and Administration
Illustrative example 4 - Capital incentive – payment of relocation costs
Information:
The lessor agrees to pay relocation costs incurred by the lessee as an incentive to the
lessee to enter into the new lease. The new lease has a term of 4 years and an annual
rental of $25,000 per year. Relocation costs are $1,000.
Answer:
Debit
Credit
Year 0 (lease inception)
Relocation cost expense*
1,000
Lease incentive liability
1,000
Year 1 to 4 (this journal is repeated)
Lease expense
Lease incentive liability
Cash
24,750
250
25,000
* Relocation costs are recognised in the income statement as an expense in the period
they are incurred (Interpretation 115.11).
Note – Another common form of incentive is contribution of non-monetary assets,
such as leasehold improvements. The incentive is accounted for the same as above but
an asset recorded instead of a relocation expense. This asset will then be accounted
for using the applicable accounting standard.
Contacts
Questions or comments about this Guidance Note should be addressed to Accounting
Policy Branch at [email protected]
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Accounting Guidance Note 2007/3
Department of Finance and Administration