If an operating lease has scheduled rent increases, rent is recognized “on a straight-line basis over the lease term unless another systematic and rational allocation basis is more representative of the time pattern in which the leased property is physically employed.” [FASB Technical Bulletin 85-3, ¶2] For instance, if rent is increased due to increasing availability of floor space in a building lease, it may be appropriate not to level the rent. On the other hand, a rent holiday or a later increase in scheduled rent due to an expectation of inflation must be leveled. (If the rent varies based on the actual inflation rate, the change is considered contingent rent and not leveled.)
The difference between cash rent and rent expense creates a deferred liability (if cash rent to date is less than expense, the normal situation) or a deferred asset (if cash rent to date is greater than expense, perhaps due to a bargain renewal option near the end of the lease). For a Lessor, leveling typically produces a deferred asset. Governmental entities should see Appendix D for more information.