When a person leasing property, a tenant, makes improvement to the property, the improvement is known as a leasehold improvement. Leasehold improvements are improvements that stay with the property. For example, fixing a roof is a leasehold improvement while hanging a piece of art is not. Leaseholder improvements are capitalized by the tenant to the leased property, which means even though there is an expense, the amount will go on the balance sheet and not the income statement. Then over time, the leasehold improvement expenses amortize. Amortizing means that the expenses on the balance sheets moves to the income statement. Accounting for leasehold improvements is generally done by businesses that lease property for business use.
Determine the cost of the repairs or expenditures that qualify as leasehold improvements. For example, a tenant with five years remaining on his lease installs a new roof. The total cost of this improvement was $100,000, which the tenant pays in cash, and the improvements should last 20 years.
Determine the shorter of the life of the lease or the life of the improvements. In the example, the life of the improvement from the roof is 20 years and the lease is for the next five years. The accountant would choose five years because it is the shorter amount of years.
Divide the improvement costs by the useful life. In our example, $100,000 divided by five years equals $20,000 a year.
Debit "Leasehold Improvements" and credit "Cash" or "Accounts Payable" for the amount spent on leasehold improvements. In the example, the journal entries would be "Leasehold Improvements" debited for $100,000, and "Cash" credited for $100,000. This is done in the general ledger to account for the expenses paid for the leasehold improvements. Debiting "Leasehold Improvements" increases the asset's account. Crediting "Cash" reduces cash, which is an asset, while crediting "Account Payable" increases as a liability because the tenant has yet to pay for the expenses.
Debit "Depreciation Expense - Leasehold Improvements" and credit "Accumulated Depreciation - Leasehold Improvements" each year by the amount calculated in Step 3. In the example, each year the tenant would debit "Depreciation Expense - Leasehold Improvements" by $20,000 and credit "Accumulated Depreciation - Leasehold Improvements" by $20,000. This journal entry amortizes the leasehold expenses from the balance sheet to the income statement. Debiting "Depreciation Expense - Leasehold Improvements" is an income statement account, which increases when debited. "Accumulated Depreciation" is a contra-account to the "Leasehold Improvement" account. A contra-account decreases the account it is associated with. So, by crediting "Accumulated Depreciation - Leasehold Improvements" you are decreasing the "Leasehold Improvements" asset account.
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