A make-good obligation in a commercial lease is a contractual requirement for the tenant to return the premises to its original condition - or a specified condition - at the end of the lease term. This means undoing fit-out works, removing installed partitions, reinstating flooring and ceilings, repainting walls, and generally reversing any physical changes made during occupancy. From an accounting perspective, this obligation must be recognised as a provision (a liability) on the tenant's balance sheet when the obligation arises - which is at lease commencement for general restoration obligations, or when the tenant installs leasehold improvements for fit-out specific obligations. The corresponding debit goes either to the right-of-use (ROU) asset or to the leasehold improvement asset, depending on the nature of the obligation. In practice, most entities capitalise restoration provisions to the ROU asset unless the obligation is directly attributable to specific leasehold improvements. That upfront recognition requirement catches many tenants and property managers off guard.

Why Make-Good Clauses Exist

When a landlord hands over a commercial premises, it is typically in a base-build condition - carpeted, painted, and configured as an open floor plan. The incoming tenant then fits it out to suit their business: partitions, custom lighting, raised flooring, data cabling, kitchen fitouts, and branding elements.

The problem is that the next tenant may need an entirely different configuration. A landlord whose outgoing tenant leaves behind a heavily partitioned, highly customised space faces a significant re-leasing cost to strip it back. Make-good clauses shift that cost to the outgoing tenant - requiring them to remove their fit-out and return the space to the condition specified in the lease before they hand back the keys.

This is why make-good provisions are almost universal in:

• Office leases with significant tenant fit-out

• Retail leases where the tenant has undertaken structural modifications

• Industrial leases involving specialised plant, equipment installation, or hazardous material handling

• Any lease where the tenant's use meaningfully changes the physical configuration of the premises

Make-good is not the same as general wear and tear. Normal deterioration from regular use is typically the landlord's responsibility. Make-good addresses deliberate modifications - things the tenant added, changed, or removed during the lease. Understanding this distinction is critical when interpreting the scope of a make-good clause and estimating the financial exposure it creates.

This is one of the many obligations that needs to be tracked carefully throughout the full lifecycle of a commercial lease.

What Make-Good Typically Includes

Make-good obligations vary significantly by lease and property type, but common requirements include:

Physical reinstatement works :

• Removal of internal partitions, walls, and office configurations installed by the tenant

• Reinstatement of flooring to original specification (removing carpet tiles, raised flooring, or specialist surfaces)

• Removal of suspended ceilings or reinstatement of original ceiling finishes

• Repainting all surfaces in the landlord's specified colour

• Restoring base-build air conditioning, fire services, and hydraulic systems to original layout

• Removal of signage, branding elements, and custom lighting

General restoration :

• Carpet cleaning or replacement to a specified standard

• Servicing of air conditioning and mechanical systems

• Repair of any damage caused during tenancy (beyond normal wear and tear)

What is typically excluded :

• Normal wear and tear from regular use

• Improvements the landlord has explicitly agreed to retain in writing

• Works completed with the landlord's written consent that are to be left in place

How Make-Good Is Accounted For - Step by Step

This is where most tenants, and many property managers, make errors. Make-good is not simply expensed when the work happens at lease end. Under both US GAAP (ASC 842 and ASC 410-20) and IFRS 16, the obligation must be recognised when it arises, using the present value of the estimated future cost.

Step 1: Estimate the Cost at the Point the Obligation Arises

At the point the obligation is incurred - lease commencement for general restoration, or when fit-out works are installed for specific reinstatement obligations - the tenant must estimate what it will cost to return the premises to its required condition at lease end. This is not a guess - it requires a reasonable assessment of the scope of the make-good obligation and an estimate of labour and materials costs at the time of reinstatement, adjusted for inflation where applicable.

Example: A tenant commences a 5-year office lease. The lease requires removal of all fit-out at expiry. The tenant estimates the reinstatement will cost $80,000 in today's terms, escalating to approximately $98,000 by lease end (allowing for cost inflation). Using a discount rate of 6%, the present value of this future obligation at lease commencement is:

PV = $98,000 ÷ (1.06)⁵ = $73,232 

This $73,232 is the amount recognised as a provision on day one.

Step 2: Initial Journal Entry

The accounting treatment depends on whether the make-good obligation relates to general restoration (such as repainting or servicing systems) or specific leasehold improvements the tenant has installed (such as partitions or raised flooring).

If related to general restoration → capitalise to ROU asset:

Dr  Right-of-Use Asset          $73,232
    Cr  Make-Good Provision          $73,232

If related to specific tenant fit-out → capitalise to leasehold improvement:

Dr  Leasehold Improvement Asset    $73,232
    Cr  Make-Good Provision             $73,232

The asset is then depreciated/amortised over the shorter of the lease term or the asset's useful life. The provision is unwound each year using the effective interest method.

Step 3: Annual Unwinding of Discount (Interest Accretion)

Each year, the provision grows as the discount unwinds - this is recorded as a finance/interest cost:

The journal entry each year:

Dr  Interest/Finance Expense    $4,394
    Cr  Make-Good Provision         $4,394

By year 5, the provision has grown to approximately the estimated reinstatement cost - which is exactly how it should work.

Step 4: Reassessment at Each Reporting Date

The estimated make-good cost must be reassessed at each balance sheet date. If the estimate changes - because the scope of works has changed, cost assumptions have shifted, or the lease term has been extended - the provision is adjusted:

• Increase in estimate → debit the ROU asset or leasehold improvement asset (increases the carrying value)

• Decrease in estimate → credit the ROU asset or leasehold improvement asset (reduces the carrying value), except where the asset is already fully depreciated, in which case the reduction flows through the income statement as a gain

Step 5: Settlement at Lease End

When the tenant physically carries out the make-good works, the provision is derecognised:

Dr  Make-Good Provision    $98,001
    Cr  Cash / Accounts Payable    $98,001

If the actual cost differs from the provision, the difference is recognised as a gain or loss in the income statement in the period of settlement.

Physical Make-Good vs. Cash Settlement

Not all make-good obligations are settled by physically reinstating the premises. Landlords and tenants frequently negotiate a cash settlement instead - the tenant pays the landlord an agreed amount rather than carrying out the works themselves.

From a financial management perspective, tenants who manage their own make-good works typically spend significantly less than the cash settlement the landlord would accept - because the landlord's settlement figure normally includes a margin. However, a cash settlement provides certainty and eliminates the operational complexity of managing a construction project during a relocation.

The Landlord's Perspective: Accounting for Make-Good Receipts

From the landlord's side, make-good is handled differently. Landlords do not recognise a make-good provision - they simply maintain the property at its existing book value. If a cash settlement is received from a departing tenant:

• The payment is recognised as income in the period received, typically classified as lease termination income or other operating income

• If the landlord subsequently spends money reinstating the premises, those costs are either expensed (maintenance/repairs) or capitalised as a property improvement if they meet capitalisation criteria - these are two separate transactions

• Care must be taken to avoid double-counting economic benefits when recognising income and capitalising subsequent improvements

This distinction matters for landlords managing large commercial portfolios with regular lease turnover.

For a broader view of how these cash flows interact with overall lease administration, the early lease termination guide covers the accounting treatment on both sides of the ledger when a commercial lease exits.

Common Make-Good Accounting Mistakes

These are the errors that come up most regularly in commercial property accounting:

• Not recognising the provision when the obligation arises :

  Many tenants defer recognition until make-good works are imminent. This understates liabilities throughout the lease term and creates a large one-time expense at lease end that distorts the income statement.

• Using undiscounted estimates :

  The provision must reflect the present value of the future obligation, not just the estimated nominal cost. Using undiscounted figures overstates the provision in early years.

• Failing to reassess annually :

  The provision must be reviewed at each reporting date. Scope changes, cost escalation, and lease modifications all affect the estimate and must be reflected promptly.

• Capitalising the wrong asset :

  General restoration goes to the ROU asset. Fit-out specific make-good goes to the leasehold improvement. Mixing these up creates depreciation errors that compound over the lease term.

• Forgetting the unwinding of discount :

  The annual interest accretion must be recorded as a finance cost. Omitting this understates both the provision balance and the interest expense each year.

• Missing make-good clauses during lease abstraction :

  If the make-good obligation isn't identified and recorded when the lease is executed, the entire provision recognition is missed.

  This is one of the core reasons why rigorous property management accounting practices and structured lease data management matter so much.

FAQs

Q1. Is make-good the same as dilapidations?
Essentially yes - dilapidations is the UK term for the same concept. Both refer to the tenant's obligation to return the premises to a specified condition at lease end, covering reinstatement of fit-out, repairs, and restoration. The accounting treatment under IFRS 16 / IAS 37 is the same regardless of which term is used.

Q2. When exactly must the make-good provision be recognised?
The provision is recognised when the obligation arises - not necessarily at lease commencement. For general restoration obligations (repainting, carpet cleaning, servicing systems), the obligation arises at lease commencement. For obligations tied to specific fit-out works installed by the tenant during the lease, the provision is recognised when those works are installed.

Q3. What discount rate should be used to calculate the present value of the make-good provision?
Standards prescribe risk-adjusted discount rates - a pre-tax risk-free rate adjusted for liability-specific risks under IAS 37, and a credit-adjusted risk-free rate under ASC 410-20. In practice, many entities use their incremental borrowing rate as an approximation, though this proxy should be reviewed with your auditors to confirm it is appropriate for your specific circumstances and jurisdiction.

Q4. What happens to the make-good provision if the lease is extended?
The provision must be remeasured to reflect the changed timing and cost assumptions. Extending the lease changes both the discounting period and the projected cost at settlement - the net effect may increase or decrease the provision depending on the balance between the longer discounting horizon and cost escalation over the extended term.

Q5. Can a make-good obligation be waived?
Yes, if the landlord agrees in writing to release the tenant from the obligation - either as part of a lease renewal negotiation or an early exit arrangement. When the obligation is formally waived, the provision is reversed and any remaining balance is recognised as a gain in the income statement.

Q6. How does make-good interact with a tenant improvement allowance (TIA)?
The TIA reduces the total lease consideration and lowers the straight-line rent expense - but it does not eliminate the make-good obligation. If the landlord funds the fit-out through a TIA and the lease still requires reinstatement at expiry, the tenant must still recognise a make-good provision for the full estimated cost of removing that fit-out. The TIA and the provision are accounted for independently.

Conclusion

Make-good is one of those lease obligations that sits quietly in the back pages of a lease document and doesn't demand attention until the last few months of a tenancy - when it's too late to plan for it properly. The financial exposure can be significant. For a mid-sized office tenant occupying 2,000 square meters with a full fit-out, reinstatement costs can easily run into hundreds of thousands of dollars.

The accounting treatment requires that this exposure be recognised from the moment the obligation arises - as a discounted provision on the balance sheet, unwound annually, and reassessed at every reporting period. Getting this right isn't just a compliance requirement. It's what gives landlords, tenants, and their finance teams an accurate picture of the true financial obligations embedded in every commercial lease.

If you're managing a portfolio with multiple commercial leases and want to ensure make-good obligations, provision balances, and critical lease-end dates are tracked without anything falling through the cracks, RIOO is built to handle exactly that kind of lease administration at scale.

For the authoritative accounting guidance on make-good provisions under international standards, Grant Thornton's technical alert on leasehold make-good and restoration provisions is one of the most thorough publicly available references on the topic.