Deferred rent accounting occurs when a tenant is given free rent in one or more periods, usually at the beginning of a lease agreement. To account for these free periods, as well as subsequent periods, the essential accounting is as follows:
Compile the total cost of the lease for the entire lease period. For example, if a lease is for one year with the first month free, and rent payments in all other months are $1,000, then the total cost of the lease is $11,000.
Divide this amount by the total number of periods covered by the lease, including all free occupancy months. To continue with the same example, this would be $917, which is calculated as $11,000 divided by 12 months.
In every month of the lease, charge the average monthly rate to expense, irrespective of the actual monthly payment made. Thus, the expense in the first month of the example situation is for $917. There is no actual payment in that month, since the tenant is being given a free month of occupancy. This means that the $917 debit to expense is offset by a credit to the deferred rent account, which is a liability account.
In all successive months of the lease, continue to charge the same average amount to expense. If an offsetting rent payment is made (a credit to reduce cash) and the payment does not match the expense, the difference is charged to the deferred rent liability account. To continue with the example, the monthly payment in all other months is $1,000, which is $83 higher than the amount charged to rent expense. This difference is used to reduce the amount of the deferred rent liability over the remaining months of the lease, until it is reduced to zero.
The same approach to deferred rent accounting applies when the rent amount changes over time. For example, if the lease rate increases after a number of months, the average rent expense is still charged in all months, with a portion of this charge being included in the deferred rent liability. Later, when payments match the higher rate but the average rent expense is still being charged, the deferred rent liability will gradually decline.