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Accounting for Closed Stores with An Active Lease

Accounting for Closed Stores with An Active Lease

I will discuss accounting for closed stores in this post. I chose this topic because one of the companies that I used to work for operates through a network of retail stores across the U.S. These retail stores sell products directly to customers. When I first began with the company, I was assigned two states to manage. It means that I was responsible for the accounting of all the properties in those two states.

I remember there was one store that was shut down in the month that I joined the company. Even though the store was ended, its lease would not expire until two years later. I needed to prepare a journal entry (JE) to account for that closed store. Still, I did not know how to do it. I had never done any JE like that in my previous jobs. Like everybody else would do, I turned to Google for help. However, to my surprise, there was nothing useful that I could find about accounting for closed stores with an active lease. As a result, it took me a lot of time to figure out how to do the entry myself. For this reason, I wanted to share in this post how to account for closed stores before their lease ends.

Overview of Accounting for Closed Stores with An Active Lease

For simplicity’s sake, let’s consider this example. There is a property called “Store Dao,” which is owned by Tuong (me). I am the owner and the accountant of the store. In addition, this property is closed in July 2020, but the lease will not expire until December 2021. Under U.S. GAAP,  I need to accrue for all expenses that will continue to exist under the store’s contract for its remaining term without any economic benefit to my property. These costs include base rent, property tax, utilities, insurance, etc. My job is to estimate the total of the costs and accrue for that total amount.

If you have been following my website, you know that I got my Master’s degree from Cal State Fullerton. During my time there, I learned about this subject, accounting for closed stores, in one of my accounting classes. Nonetheless, I did not understand the concept at that time due to my lack of experience. When I got chances to do this entry at work, I recalled the knowledge that I acquired from school, and everything started to make sense to me.

Accounting for Closed Stores: Journal Entry to Accrue for Closure Expenses

After I estimate all the costs that can exist after my property is closed, I go on and book a reserve to recognize the costs and make a reservation. This is an essential entry in accounting for closed stores. It is noteworthy that because these costs will become extraordinary costs after my store stops operating, they go to an expense account that is excluded from the EBITDA calculation. Accounts like this are called “below-the-line” accounts. If the estimated total expense is $100000, the JE for this accrual is debiting a below-the-line account for $100000 and crediting a liability reserve account for $100000, which is a liability account.

DebitCredit
Below-the-Line Expense$100,000
Reserve Account$100,000

Journal Entry to Reverse Actual Expenses Incurred

In the following months, when actual costs are incurred, the charges will be credited against the reserve account. Let’s assume that in August 2020, base rent is $2000, and utilities are $100. The entry that I need to create is debiting the reserve account for $2100, crediting utility expense account for $100, and crediting rent expense for $2000. This JE will be monthly until the lease ends.

DebitCredit
Reserve Account$2,100
Base Rent$2,000
Utilities$100

Journal Entries for Late Accrual of Closure Expenses

Now let’s pretend that I am negligent and forget to book this accrual JE until December 2020. Negligence is unavoidable, not just in accounting for closed stores, but in anything! The entry that I need to prepare in December 2020 will be a bit more complicated. Actually, there are separate entries that should be created. Let’s say the total of actual costs incurred in the period from June 2020 to December 2020 is $15000, including $10000 rent, $3000 insurance, and $1000 utilities. My estimation of the expenses from December 2020 until the expiration date is $70000. The JE will be crediting rent expense for $10000, crediting insurance for $3000, crediting utilities for $1000, and debiting a below-the-line account for $15000. As can be seen, because these costs are real, not estimated, they are reclassified to the below-the-line account, not the reserve account.

DebitCredit
Below-the-Line Expense$15,000
Base Rent$10,000
Insurance$3,000
Utilities$1,000

The second JE is to recognize the estimated expenses for the remaining term of the contract. It is debiting the below-the-line account for $70000 and crediting the reserve account for $70000.

DebitCredit
Below-the-Line Expense$70,000
Reserve Account$70,000

Journal Entry for Lease Buyout

The last situation that I can think of is lease buyouts. Let’s assume I successfully negotiate a lease buyout of $60000 to get out of the lease. I pay for the buyout in July 2020. The JE is crediting rent expense for $60000, debiting the reserve account for $100000, and crediting the below-the-line account for $40000.

DebitCredit
Reserve Account$100,000
Base Rent$60,000
Below-the-Line Expense$40,000

That is all about the accounting for closed stores with an active lease. I think this kind of journal entries are common in businesses where there are many retail stores. Companies usually close stores that are not making a profit to reduce costs. They then use that money to open new stores in new locations. If you encounter this situation and need to book accrual entries for your closed properties, this post is for you. I hope you find it helpful. Happy reading!!!

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