Overview
A rental deposit is cash a lessee pays to a lessor as security, to be returned at the end of the lease. Under IFRS, the deposit is not a lease payment. It is a separate financial asset of the lessee, recognised at fair value under IFRS 9 and excluded from the lease liability.
The accounting depends on whether the deposit earns interest:
| Interest-bearing (market rate) | Interest-free | |
|---|---|---|
| Initial recognition | Amount paid | Present value of the refund |
| Right-of-use asset | No effect | Excess of cash paid over present value added |
| Interest income | Interest earned on the deposit | Unwinding of the discount |
This article forms part of our full IFRS 16 guide.
Interest-Bearing Deposits
Where the deposit earns a market-related rate of interest, the cash paid is its fair value. The lessee recognises:
- At commencement: a financial asset equal to the amount paid.
- Each period: interest income as it accrues, whether paid out or added to the deposit.
- At the end of the lease: the refund, which derecognises the asset.
The right-of-use asset and lease liability are not affected. The deposit is measured at amortised cost, as it is held to collect cash flows that are solely principal and interest.
Interest-Free Deposits
Initial recognition
An interest-free deposit refunded in several years is worth less than the cash paid. IFRS 9 requires it to be recognised at fair value (IFRS 9.5.1.1), measured as the present value of the refund (IFRS 9.B5.1.1).
The discount rate is a market rate for a similar receivable: one due from the lessor, for the same period. It reflects the lessor's credit risk, so it is not necessarily the lessee's incremental borrowing rate.
The excess of cash paid over fair value
IFRS 9.B5.1.1 requires the excess to be expensed unless it qualifies as another asset. IFRS 16 does not address deposits directly, but the excess is generally treated as a lease payment made at commencement and added to the right-of-use asset (IFRS 16.24(b)). The lessee gives up interest on the deposit to obtain the right to use the premises, so it is part of the consideration for the lease.
Subsequent measurement
The deposit is measured at amortised cost, and the discount unwinds as interest income until the refund date. The additional right-of-use asset is depreciated over the lease term. Over the life of the lease, the extra depreciation equals the interest income, but the timing differs.
A deposit earning below-market interest is treated in the same way. The excess is smaller, as part of the return is received as interest.
Practical Example
A lessee enters into a five-year lease of retail premises and pays a deposit of 60,000 at commencement. The deposit earns no interest and is refunded at the end of the lease. The market rate for a five-year receivable from the lessor is 9%.
Fair value of the deposit: 60,000 ÷ 1.09⁵ = 38,996. Excess added to the right-of-use asset: 60,000 − 38,996 = 21,004.
| Commencement journal | Dr | Cr |
|---|---|---|
| Rental deposit (financial asset) | 38,996 | |
| Right-of-use asset | 21,004 | |
| Bank | 60,000 |
The deposit then accrues interest at 9% each year:
| Year | Opening | Interest income (9%) | Closing |
|---|---|---|---|
| 1 | 38,996 | 3,510 | 42,506 |
| 2 | 42,506 | 3,825 | 46,331 |
| 3 | 46,331 | 4,170 | 50,501 |
| 4 | 50,501 | 4,545 | 55,046 |
| 5 | 55,046 | 4,954 | 60,000 |
The 21,004 in the right-of-use asset is depreciated at 4,201 per year. At the end of the lease, the 60,000 refund derecognises the deposit asset.
Had the deposit earned interest at 9%, the lessee would simply recognise a 60,000 financial asset and interest income of 5,400 per year, with no change to the right-of-use asset.
Lessor Accounting
The lessor has an obligation to repay the deposit, so it recognises a financial liability at amortised cost under IFRS 9.
- Interest-bearing deposit: the liability equals the amount received, and interest payable is recognised as interest expense.
- Interest-free deposit: the liability is recognised at the present value of the refund. The excess of cash received is an additional lease payment. For an operating lease, it is deferred and recognised as rental income on a straight-line basis over the lease term (IFRS 16.81). For a finance lease, it is taken into account in measuring the net investment in the lease.
Using the example above, the operating lessor records Dr Bank 60,000, Cr Deposit liability 38,996 and Cr Deferred rental income 21,004, then releases rental income of 4,201 per year while the liability unwinds through interest expense. See lessor accounting.
Other Types of Deposits
Not every deposit is refunded in cash:
| Deposit | Treatment |
|---|---|
| Applied against the final rental | Prepaid lease payment, included in the right-of-use asset |
| Non-refundable | Lease payment made at or before commencement, included in the right-of-use asset |
| Bank guarantee instead of cash | No deposit asset; guarantee fees expensed |
Practical Considerations
- Materiality. For small interest-free deposits or short leases, the discounting effect is often immaterial. Many entities carry these deposits at the amount paid and document that judgement.
- Change in refund date. If the lease term is reassessed or modified and the expected refund date changes, the amortised cost is recalculated at the original effective interest rate, with the adjustment in profit or loss (IFRS 9.B5.4.6).
- Expected credit losses. The deposit is subject to IFRS 9 impairment. The allowance is usually small but increases if the lessor's financial position weakens.
- Amounts withheld. If the lessor withholds part of the deposit for repairs, that amount settles the lessee's restoration costs. Expected restoration obligations are accounted for separately under IAS 37.
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Conclusion
A rental deposit is a financial asset under IFRS 9, not a lease payment. A deposit earning market-related interest is recognised at the amount paid, with interest income as it accrues. An interest-free deposit is recognised at the present value of the refund, with the excess of the cash paid generally added to the right-of-use asset and the discount unwinding as interest income. Lessors mirror this with a financial liability and, for interest-free deposits under operating leases, deferred rental income.
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