Lease Accounting

Using the Straight-Line Method of Expense in Lease Accounting

By: Jess Vento

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Straight-line rent expense spreads the total lease payments for an operating lease evenly across the lease term, no matter when cash changes hands. Under ASC 842, add up the fixed payments over the full lease term, counting free-rent months at zero and including fixed escalations, then divide by the number of periods.

In summary: leases are amortized, and underlying assets are depreciated, as depreciation is the decline in an asset’s value over the course of a lease.

Amortization and depreciation are not new concepts that came about with the new lease standards; the depreciation of assets and amortization of capital leases (now finance leases) are something that lessees and lessors have done for decades.

To account for rent payments and measure rent expenses, there are a few things to keep in mind, including the recognition of a straight-line rent expense.

What is the Straight-Line Method of Expense for Lease Accounting?

The straight-line method of expense is a way to recognize lessee lease payments on the income statement. With the straight-line method, all lease payments are distributed evenly across the term of the lease, regardless of when the lessee actually makes their lease payments. The straight-line expense method has always been required for operating leases because a lessee controls the underlying asset consistently throughout the term of the lease, so the related expense must be recognized on a consistent basis as well.

Lease payments could be on a typical lease amortization schedule, like month-to-month, or a lessee could pay everything up-front, or there could be a buy-out option at the end of the lease. The straight-line method cuts through all the noise of the varying times at which a lessee pays their rent and shows the payments distributed evenly over the course of the lease.

Let’s consider an example with a buy-out situation. Say you have $1,000 monthly payments over a two-year lease term that total $24,000. If there’s a buy-out for $12,000, the total of the monthly payments plus buy-out is $36,000. To recognize that total expense evenly over the lease term, divide the total by the duration of the lease in months (24 months). The straight-line expense is $3,000 each month.

Straight-Line Rent Expense Under ASC 842

Under ASC 842, a lessee recognizes a single lease cost, allocated over the remaining lease term on a generally straight-line basis. The lease liability of these assets is the present value of future lease payments. The right-of-use asset is the lease liability plus initial direct costs and lease payments made at or before lease commencement, less incentives received.

Regardless of how and when lease payments are made for these operating leases, the lease expense, which is the same as the straight-line rent expense recognized under ASC 840 for operating leases, should be recorded on the income statement.

How Do You Calculate Expense Using the Straight-Line Method?

Calculating the straight-line expense of an asset is incredibly straightforward. You just take the total amount of lease payments and divide it by the number of months of the lease term. This process is the same for both ASC 840 and 842.

Straight-Line Rent Expense Measurement Considerations

These factors may also need to be factored into your straight-line rent expense measurement:

Lease incentives

Sometimes a lessor offers a lease incentive to a lessee for funding lessee improvements to the underlying asset or to entice the lessee to sign a lease in a more difficult leasing environment. If the lease incentive is not paid by the lease commencement date, that lease incentive reduces the lessee’s lease payments at the expected receipt date, reducing the lease liability along with the ROU asset.

Rent-free periods

There’s a change in mindset on the accounting treatment for periods when a lessee is not required to pay rent within a lease. Under the previous lease standard, ASC 840, this often resulted in deferred rent balances on the balance sheet. With ASC 842, there is no deferred rent balance to maintain because this amount is accounted for in the lease liability and ROU asset.

Rent escalations

When base rent payments increase in a lease, the known changes should be factored into the Lease Liability and ROU Asset as well as straight-line rent expense calculations.

What is a Straight-Line Expense Example?

Here’s an example of the straight-line method of expense:

Suppose a lessee had control of an underlying asset as of January 1, 2023, which means that’s also when the lease term commenced. According to the contract agreed upon by the lessor and lessee, the lessee doesn’t have a lease payment for the first six months of their lease, so the first lease payment is July 1, 2023.

Starting July 2023, the monthly lease payments are $1,000 for the remainder of the two-year lease, totaling $18,000. Divide that $18,000 by the full lease term of 24 months and the straight-line expense is $750/month.

Why is Straight-Line Expense Important?

The straight-line expense method serves multiple purposes in lease accounting:

1. 1.It ensures expenses are matched to the specific time period the asset is used, regardless of payment intervals. It also properly accounts for the lessee's right to use the asset throughout the entire lease term. Thus, organizations recognize expenses consistently over the appropriate duration of asset usage.
2. 2.It attempts to eliminate hijinks with lease payments, where an organization could time payments in a manner that would materially increase or decrease expenses to manipulate their financial statements.
3. 3.Importantly, it makes the accounting for leases more transparent for the financial statement users.

What is Straight-Line Depreciation?

Straight-line depreciation refers to the decrease in the value of tangible assets, such as an office building, equipment, or vehicles. Tangible assets are often described as fixed assets, PP&E (property, plant & equipment), or FF&E (furniture, fixtures, and equipment) on a balance sheet. To represent the fact that these types of assets decline in value over time, the underlying assets are depreciated and leases are amortized.

How to Calculate Straight-Line Depreciation

Straight-line depreciation is simple to calculate. First, determine the cost of the asset, less the estimated salvage value. Then determine the useful life of the asset and divide the cost of the asset by the useful life to determine the straight-line depreciation which is often recorded on a monthly basis.

Straight-Line Depreciation Formula

The straight-line depreciation formula is:

(cost of the asset - estimated salvage value) / the estimated useful life of the asset

These values are defined as the following:

• ​Cost of the asset is the price of the asset at its purchase
• ​Salvage value the asset is estimated to be worth at the end of its useful life
• ​Useful life of the asset is the number of periods or years in which the asset is to be in service

Lease Accounting Software for Straight-Line Method of Expense

The straight-line method of expense isn’t too difficult a concept to grasp and execute, but it can be as simple as the click of a button with Crunchafi’s easy-to-use lease accounting software (formerly LeaseCrunch).

Sign up for a demo today to see how much faster you could be performing your lease accounting!

Frequently Asked Questions

Does GAAP require straight-line rent?

Yes. Under ASC 842, a lessee recognizes a single lease cost for an operating lease, allocated over the remaining lease term on a generally straight-line basis unless another systematic and rational basis is more representative of the pattern in which benefit is expected to be derived from the right to use the underlying asset.

Do you have to use the straight-line rent method?

For operating leases under ASC 842, lessees use the straight-line single lease cost in most cases. Finance leases are different: the lessee recognizes amortization of the right-of-use asset and interest on the lease liability. IFRS 16 has no operating lease category for lessees, so lessees recognize depreciation and interest for leases on the balance sheet. Short-term and low-value leases a lessee elects to exempt are expensed on a straight-line or other systematic basis.

What is straight-line deferred rent?

Under ASC 842, deferred rent is no longer tracked as its own balance. Under ASC 840, deferred rent was the difference between what the lessee paid and the straight-line expense. Under ASC 842, that difference is reflected in the right-of-use asset, which is measured as the lease liability adjusted for accrued or prepaid rent.

What is the straight-line expense for ASC 842?

The straight-line expense for ASC 842 is the even allocation of operating lease cost over the lease term, regardless of when payments are made. To calculate it, divide total lease payments by the number of periods in the lease term.

What is an example of straight-line depreciation?

A company car costs $25,000 and has a $5,000 salvage value, so the depreciable amount is $20,000. Over a 5-year useful life, annual straight-line depreciation is $4,000.

What is the straight-line amortization of intangibles?

Straight-line amortization reduces the value of an intangible asset at a constant rate over its useful life. Divide the asset's cost, less any residual value, by its useful life.

How many years does a straight-line expense last?

As long as the lease term, or for depreciation, the useful life of the asset.

How do free-rent periods affect straight-line rent expense?

Free-rent months are part of the lease term, so total payments are spread over every month, including the free ones. In a 24-month lease with six free months and $1,000 payments after that, straight-line expense is $18,000 divided by 24, or $750 a month.

How do rent escalations affect straight-line rent expense?

Known, fixed escalations are included in total lease payments at commencement, so the expense stays level while cash payments rise. Payments tied to an index such as CPI use the index at commencement; later changes are recognized as variable lease cost when they occur.

Related resources

Accounting for GASB 87 and GASB 96\ \ Lease Accounting

What are Right of Use Assets?\ \ Lease Accounting

Why CPA Firms Must Embrace Automation & Client-Centric Audits\ \ Lease Accounting

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