Accounting for restoration costs (Journal Entries and Explanation)

Meaning

A tenant should recognize restoration cost as part of the right of use asset while incurring obligation for them. Based on the circumstances, this shall be decided that it may start at the commencement date or be a consequence of having used the asset for a particular period.

The obligation is covered under IAS 37 Provisions, Contingent Liabilities, and Contingent Assets. Regular wear and tear occur during the lease period, which can increase the tenant’s hand-back obligation but does not give rise to an asset.

Further, the tenant shall apply provisions of IAS 2 Inventories if the leased asset is used to manufacture inventories in the lease period.

Accounting and journal entry

The legal owner of the asset may require the lessee/tenant to reinstate the leased space to its original state when the lease expires, and the tenant decided not to renew the lease agreement.

Then, a provision for reinstatement cost/restoration cost needs to be recorded, as it is an existing obligation of the lessee/tenant.

This amount relates to the cost incurred to reinstate the lease space back to its original state. Such an amount is estimated with the help of a quotation from a renovator or building contractor.

DateParticularsDebit ($)Credit ($)
 XXXXReinstatement costX,XXX 
 XXXXProvision for reinstatement X, XXX
   
(To record reinstatement cost)

The amount capitalized above relates to the full cost to be incurred when the lease expires. For closing the account following entry shall be

DateParticularsDebit ($)Credit ($)
 XXXXReinstatement Cost- Profit and Loss AccountXXX 
 XXXX   Accumulated depreciation/ Fixed asset- reinstatement cost XXX
    

The depreciation entry is to record the cost capitalized into P&L on a straight-line basis. The reinstatement or restoration cost has to be expensed off straight-line until the end of the lease period.

Related article  What Is the Residual Value of Fixed Assets and How to Calculate It

Impact of increase in lease term

In the initial period, the tenant measures the asset’s right to use and includes appropriate estimates of the cost to dismantle and remove the asset or restore the asset to the prior situation before the contract begins.

The obligation for these costs is recognized and measured by IAS 37. The changes to the best estimate of the settlement amount may result from changes in the amount or timing of the outflows or discount rates.

A lease modification may result in a change to a tenant’s obligations to restore the underlying asset at the end of the lease. This may result in additional provisioning of restoration costs and should be provided immediately.