Straight-line rental income for landlords

What is straight-line rental income?

Under IFRS 16, a landlord that keeps the risks and rewards of ownership has an operating lease. It recognises the lease payments as income on a straight-line basis over the lease term, unless another systematic basis better reflects the pattern in which the benefit of the property is used up. For buildings let at a rent, straight-line is almost always the answer. The difference between the rent invoiced and the income recognised builds up in an accrued income asset. Service charges recovered from tenants are not rent: they are a separate service, covered in service charges.

Straight-line rental income: a five-year office lease

A landlord lets an office floor for five years. The tenant gets the first six months rent-free, then pays CU 100 thousand a year for the rest of years 1 and 2, 110 thousand in years 3 and 4 and 120 thousand in year 5. Total rent is 490 thousand, so income is 490 / 5 = 98 thousand a year.

In year 1 the landlord recognises 98 thousand of income but invoices only 50 thousand, so it records an accrued income asset of 48 thousand: debit accrued income, credit rental income. From year 3, rent invoiced exceeds income and the balance unwinds, reaching nil when the lease ends.

Which rent changes are spread and which are not?

• Spread: rent-free and half-rent periods, fixed stepped rents, fixed percentage increases such as 3% a year, and the minimum level of any increase that is guaranteed, such as a floor on an inflation-linked review.
• Not anticipated: increases linked to an inflation index above any guaranteed minimum, which are recognised from when they take effect; open market rent reviews, which reset the rent when they happen; and turnover rents based on the tenant's sales, which are variable payments recognised as the sales occur.

Lease incentives other than rent-free periods, such as cash paid to the tenant for its fit-out, also reduce the income spread over the term. See lease incentives for landlords.

What lease term is used?

The same lease term as the tenant uses: the non-cancellable period, plus periods covered by an extension option the tenant is reasonably certain to exercise, and periods after a break option the tenant is reasonably certain not to use. A lease with a tenant break after three years and a rent-free period at the start is spread over three years, not five, unless the break carries a penalty large enough to make exercise unlikely. See IFRS 16 lease term.

How does accrued rent interact with investment property fair value?

A valuer values the building with its leases, so the valuation already includes the rent still to come. If the landlord also carries an accrued income asset, the same cash would be counted twice. IAS 40 therefore requires the carrying amount of investment property at fair value to exclude accrued or prepaid operating lease income recognised as a separate asset. If the valuation at the end of year 1 is CU 5,000 thousand, the property is carried at 4,952 thousand and accrued income at 48 thousand, together equal to the valuation. See investment property: fair value or cost.

What if the lease is modified or ends early?

A change to an operating lease, such as an extension with a new rent-free period, is accounted for as a new lease from the date of the change. Any accrued income at that date is treated as part of the lease payments for the new lease and is spread over its remaining term. If the tenant leaves early or becomes insolvent, the accrued income relating to that lease is written off to profit or loss. See IFRS 16 lease modifications.

What about tenants who may not pay?

Rent receivables are financial assets, and landlords recognise expected credit losses on them under IFRS 9, usually with the simplified approach and a provision matrix by tenant type. The accrued income asset is also reviewed: if a tenant is expected to leave before the balance is recovered through future rent, it is written down. See the IFRS 9 provision matrix.

How does US GAAP compare?

ASC 842 also requires straight-line income for operating leases, with the same treatment of rent-free periods and fixed steps. It adds a collectibility test: if collection of substantially all the lease payments is not probable, income is limited to the cash received and the straight-line receivable is reversed. IFRS has no such test and deals with credit risk through expected credit losses. See IFRS 16 lessor accounting and real estate accounting.

This guide is general information. It is not tax or legal advice for your situation.