Journal entry for amortization of leasehold improvement

Introduction

In business, we may need to make some improvements on the leased building that we rent from the landlord for our business operation. In this case, we can capitalize the costs of improvements as a fixed asset on the balance sheet by recording the costs to the leasehold improvement account.

The costs of leasehold improvement include the costs that we spend on making alterations or customizations on the leased property such as painting the walls, changing the carpets, adding the lighting fixture, making overall improvements to the ceilings, etc.

And similar to the other fixed assets, this leasehold improvement will also need to be amortized in order to spread its cost over the useful life of the improvement or the lease contract. Hence, at the period-end adjusting entry, we also need to make the journal entry for amortization of leasehold improvement in order to charge the allocated or amortized cost of leasehold improvement to the income statement as an expense for the period.

Later, when the lease contract ends or if we decide to stop leasing the property before the end of the lease contract for some reason, we need to make another journal entry in order to dispose of the leasehold improvement. This is made to remove all the costs of improvements we have previously recorded as fixed assets from the balance sheet.

Capitalization of leasehold improvement

We can make the journal entry to capitalize the leasehold improvement with the debit of the leasehold improvement account and the crediting of accounts payable or the cash account.

This journal entry will increase the total non-current assets on the balance sheet by the capitalized amount of the improvement done to the leasehold.

Amortization of leasehold improvement

Later, we need to make the amortization of the leasehold improvement in order to spread the cost of the improvement over the accounting periods.

In this case, we can make the journal entry for the amortization of leasehold improvement by debiting the amortization expense account and crediting the accumulated amortization account.

In this journal entry, the accumulated amortization account is a contra account to the leasehold improvement account above. Likewise, this journal entry for amortization of leasehold improvement will increase total expenses on the income statement while decreasing total assets on the balance sheet by the same amount.

The amortization of leasehold improvement can be done by dividing the costs of leasehold improvement by the remaining term of the lease contract or the useful life of the improvement itself if the useful life is shorter than the remaining lease term.

Leasehold improvement example

For example, we spend a total of $20,000 in cash on the improvement of the leasehold building that we rent from the landlord for our business operation. And the leasehold improvement is expected to have a useful life of 10 years which is the same as the remaining term of the lease contract.

In this case, we can make the journal entry to capitalize the $20,000 as the leasehold improvement with the debit of the leasehold improvement account and credit of the cash account.

Later, we can amortize the $20,000 leasehold improvement by dividing the $20,000 by the 10 years. This results in a $2,000 amortization per year which we can record on the income statement as an expense.

Likewise, we can make the journal entry for the amortization of the leasehold improvement by debiting the $2,000 amortization to the amortization expense account and crediting the same amount to the accumulated amortization account.

This journal entry will increase total expenses on the income statement by $2,000 while decreasing total assets on the balance sheet by the same amount of $2,000.

Disposal of leasehold improvement

As mentioned, when we stop leasing the property from the landlord, we need to remove the leasehold improvement from the balance sheet. And by the end of the lease period, the leasehold improvement should have been fully amortized.

In this case, we can make the journal entry for disposal of leasehold improvement by debiting the accumulated amortization account and crediting the leasehold improvement account if the leasehold improvement has been fully amortized.

This journal entry will remove the costs of leasehold improvements together with its related accumulated amortization from the balance sheet. However, as the leasehold improvement has already been fully amortized, its net book value (cost – accumulated amortization) will already become zero. Hence, there is zero impact on total assets on the balance sheet.

However, if we end the lease agreement before the end of the lease period, the leasehold improvement that we have recorded on the balance sheet may have not been fully amortized yet. In this case, we need to record the remaining unamortized amount of leasehold improvement as an expense to the income statement.

Likewise, we can make the journal entry for the disposal of leasehold improvement that is not fully amortized by recording the remaining unamortized amount to the loss on disposal of fixed assets account as below:

Hence, this journal entry for disposal of not-fully amortized leasehold improvement will increase total expenses on the income statement while decreasing total assets on the balance sheet.

Example for disposal of leasehold improvement

For example, on January 1, we make the disposal of a $20,000 leasehold improvement as we move to a new and bigger leased building for our business operations. At the time of disposal, the $20,000 leasehold improvement has already been amortized for 8 years, in which there is a $16,000 accumulated amortization on the balance sheet.

(There were 2 years remaining on the lease contract of the old office building. However, we had informed the landlord six months prior; hence, there was no penalty for ending the lease contract before the end of the lease term.)

In this case, we can record the $4,000 remaining unamortized amount ($20,000 – $16,000) as an expense to the income statement.

Hence, we can make the journal entry for disposal of the $20,000 leasehold improvement by debiting the $16,000 and the $4,000 to the accumulated amortization account and the loss on disposal of fixed assets account respectively while crediting the leasehold improvement account with the $20,000 amount.

In this journal entry, the $4,000 loss on disposal of fixed assets will be charged to the income statement as an expense for the period. At the same time, total assets will decrease by the same amount of $4,000 as we remove the leasehold improvement that has a net book value of $4,000 ($20,000 – $16,000) from the balance sheet.