How to capitalize leasehold improvements

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Leasehold improvements are capitalised if they are permanent, extend the life of the asset and/or improve the productivity of the asset. If leasehold improvements cannot be removed and revert back to the lessor at the end of the lease, then they are considered permanent.

If the leasehold improvements change the asset to suit your needs, it is considered more productive. And if the asset will be used for a longer period because of the leasehold improvements, then its useful life has been extended (GoogleBooks: GAAP Guide Level A).

Determine if the leasehold improvements are permanent, extend the useful life of the asset and/or improve its productivity. If so, the costs are capitalised. If not or the costs are minor, they are 'expensed" (considered period costs). Routine maintenance and/or minor improvements should be expensed by debiting the maintenance expense account and crediting cash for the appropriate amount.

Add an account called "Leasehold Improvements" to the non-current assets section of the general ledger. Then add a contra account called "Depreciation of Leasehold Improvements" to the same section of the general ledger. Make sure the new accounts are numbered appropriately so they fit within the non-current assets account grouping.

Capitalise the leasehold improvement when construction begins by debiting the leasehold improvements account and crediting cash or accounts payable, or both if you paid part of the costs in cash and have a remaining amount owed. Do not record any depreciation until the construction is complete and the leasehold improvements have been put into service.

Record depreciation periodically, either monthly, quarterly or annually, depending on how often you prepare financial statements. The leasehold improvements should be depreciated over the life of the asset or the remaining length of the lease, whichever is shorter. The method of depreciation should be the same or similar to other owned assets (GoogleBooks: GAAP Guide Level A). To record the depreciation, you debit "Leasehold Improvements" depreciation and credit "Leasehold Improvements" for the amount of depreciation.

Write off the remaining amount of the leasehold improvement if the lease is terminated prematurely. This is done by debiting Loss Due to Early Termination of Lease and crediting Leasehold Improvements at the end of the accounting period during which the lease is terminated.