Free rent is a period of time in a lease where the lessee is not required to make rent payments to the lessor. This is also known as a rent holiday. Under generally accepted accounting principles, or GAAP, lessees generally must record rent expense on a straight-line basis over the life of the lease. This means the lessee may record an amount of rent expense during a period in which the lease required no cash payments to the landlord.
Calculate the aggregate lease payments that must be made to the lessor over the entire life of the lease. For example, for a two-year lease that requires payments of $100 a month during year one ($1,200) and $150 a month during year two ($1,800), this amount would total $3,000.
Divide the aggregate lease payments that must be made to the lessor over the entire life of the lease by the number of months covered in the lease. This is the amount of rent expense that must be recorded every month during the life of the lease. In our example of a two-year lease with aggregate lease payments of $3,000, this is $3,000 divided by 24, or $125.
Make a general journal entry in which you debit the rent expense account for the monthly rent payment determined in step 2 and credit deferred rent expense, a liability account, for the same amount.
Repeat step 3 for each month during which you are granted free rent.
At the end of your free rent period, you will typically begin to unwind the deferred rent expense. You still will record the same amount of monthly rent expense, although instead of crediting the deferred rent expense account, you will first credit the entire amount of your cash payment. When the cash payment is in excess of the amount of rent expense, you must debit the excess against the deferred rent account. If the cash payment payment is less than the amount of rent expense, you must credit the difference to the deferred rent account.