Rent Accounting for ASC 842: Prepaid Rent, Journal Entries, and More

Picture it as a treasure chest nestled in the financial landscape, waiting to be unlocked as time unfolds. This classification reflects the prospective economic benefits that will manifest in future periods as the tenant enjoys the shelter provided. The asset status asserts its dominion in this initial phase, casting a reassuring glow on the balance sheet. Journal entries that recognize expenses related to previously recorded prepaid expenses are called adjusting entries. They do not record new business transactions but simply adjust previously recorded transactions.

Prepaid rent expense is the current asset account and is recorded in the balance sheet while rent expense is the expenses account which is recorded in the income statement of the company. When rent is paid in advance of its due date, prepaid rent is recorded at the time of payment as a credit to cash/accounts payable and a debit to prepaid rent. When the future rent period occurs, the prepaid is relieved to rent expense with a credit to prepaid rent and a debit to rent expense. In the intricate dance of financial transactions, prepaid rent emerges as a nuanced performer, seamlessly transitioning between the roles of asset and liability. As the music of accounting plays on, prepaid rent pirouettes through the stages of financial reporting, leaving its mark on balance sheets and income statements alike.

This is the more common payment arrangement, where tenants deliver their rent at the end of each period, such as monthly or quarterly. Under the cash basis system, the expenses and revenues are not recorded until the cash element is included. Base rent, also known as fixed rent, is the portion of the rent payment explicitly stated in the contract. A leasing contract may include a payment schedule of the expected annual or monthly payments. Even if the contract includes escalation increments prepaid rent assets or liabilities to the beginning or base payment amount, this type of rent is fixed. It is presented in the contract, along with planned increases, and will not change over the contract term without an amendment.

Deferred rent occurs when a company’s actual rent payments differ from the straight-line rent expense recognition over the lease term. Prepaid rent is recorded as a current asset on the company’s balance sheet. The treatment of prepaid expenses, unearned revenue, accrued income, and expenses vary in accrual and cash accounting. When the actual rent amount is paid, any variance from the minimum threshold used in the initial valuation is recorded directly to rent or lease expense.

Accounting Ratios

In this case one asset (pre paid rent) has been increased by 3,000 and the other (cash) has been reduced by a similar amount. Free rent during a lease is called an abatement and is accounted for as no lease payment under ASC 842. They pay the lessor three months in advance on the first day of every quarter. On the 1 of January they pay an advance of $6,000 to cover the first three months of the year. The amount recognized as an expense corresponds to the prepayment portion utilized during the specific period. Deferred rent is gradually recognized as an expense over the lease term, usually following the straight-line method or another appropriate method specified in the lease agreement.

In a scenario with escalating lease payments, the average expense recorded is more than the lower payments at the beginning of the lease term. Eventually, the lease payments increase to be greater than the straight-line rent expense. In the case of the rent abatement above, the company begins paying rent but the payments are larger than the average rent expense which includes the abatement period. The expense for the first two months has been incurred because the company has used the rented equipment or occupied the leased space, but cash for these services has not been paid.

Double Entry Bookkeeping

When booking journal entries, the difference (or plug) would be a credit to AP or Cash to account for the prepayment. All journal entries applicable to this scenario are illustrated in detail below. In some cases when lessee’s make large payments in advance, a remeasurement of the Lease Liability may be necessary. Under ASC 840, Deferred rent is the amount represented when there is a difference between the cash paid for rent and the straight-line rent expense. Furthermore, under ASC 842, prepaid rent is now accounted for as a part of the ROU asset instead of as a separate entry. It is important to note that the above referenced entries are how Prepaid Rent was accounted for under ASC 840.

A prepaid expense is a good or service that has been paid for in advance but not yet incurred. Common examples include rent, insurance, leased equipment, advertising, legal retainers, and estimated taxes. In business, prepaid expenses are recorded as assets on the balance sheet because they represent future benefits, but they are expensed at the time when those benefits are realized.

How Has the Accounting Treatment of Prepaid Rent Changed Under ASC 842?

The enigma persists, inviting financial connoisseurs to decipher the ballet of prepaid rent and appreciate its dual identity in the grand symphony of accounting. The business has paid the rent in advance and has the right to use the premises for the following three month period of April, May, and June. The pre paid rent account is a balance sheet account shown under the heading of current assets. Accurate accounting for prepaid assets begins with recognizing these payments as assets on the balance sheet at the time of the transaction.

• Therefore, the entry is made by debiting prepaid rent and crediting cash/bank.
• Therefore, let’s answer the question by differentiating between the current and non-current assets and current assets and liabilities.
• Eventually, the lease payments increase to be greater than the straight-line rent expense.
• As previously stated, a prepaid can be listed as an asset or a liability on the balance sheet.

Company

For example, if you have a debt obligation, such as a loan, and you owe $1,000 next month but decide to pay that amount this month, that is a prepayment. A prepaid expense, on the other hand, is any good or service that you’ve paid for but have not used yet. Each month, an adjusting entry will be made to expense $10,000 (1/12 of the prepaid amount) to the income statement through a credit to prepaid insurance and a debit to insurance expense.

In the 12th month, the final $10,000 will be fully expensed and the prepaid account will be zero. Due to the nature of certain goods and services, prepaid expenses will always exist. For example, insurance is a prepaid expense because the purpose of purchasing insurance is to buy proactive protection in case something unfortunate happens in the future. Clearly, no insurance company would sell insurance that covers an unfortunate event after the fact, so insurance expenses must be prepaid by businesses.

Our lease accounting software automates the majority of the lease accounting process, making this complicated necessity quicker, more accurate, and more compliant. In that case, the amount of rent for one month will be subtracted from the prepaid rent recorded on the balance sheet. Let’s have a look at accounting for prepaid rent on both accrual and cash basis. Prepaid rent is the amount of cash paid by an entity against future rental periods. Although the cash has been credited, the entity has not utilized the service yet. The period of non-current assets usually expands from 2 years to 10 years or more.