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The appro­pri­ate account­ing treat­ment for pre­paid rent and rent expense may vary depend­ing on the company’s spe­cif­ic cir­cum­stances and the rent­al agreement’s terms. The effect of these entries is also recor­ded in the company’s income state­ment and the bal­ance sheet. In the peri­od when pre­paid pre­paid rent assets or liab­il­it­ies rent is paid but not due, there will be no record in the income state­ment. There­fore, it ful­fills the defin­i­tion of the cur­rent assets and is recor­ded under the head of cur­rent assets on the bal­ance sheet. It is essen­tial to under­stand the dif­fer­ences related to pre­paid rent under ASC 842 for accur­ate lease account­ing. Prop­erly recog­niz­ing pre­paid rent can help ensure that your fin­an­cial state­ments com­ply with the new stand­ard and provide an accur­ate depic­tion of your company’s fin­an­cial position.

The con­cepts of Pre­paid Rent are no longer recor­ded under ASC 842 as the pay­ments are recor­ded as part of the ROU Asset. Keep read­ing to learn all about pre­paid rent, wheth­er it’s con­sidered an asset, and how to record pre­paid rent. It is essen­tial to review the lease or rent­al agree­ment terms to determ­ine wheth­er the rent is pre­paid or post­paid in a par­tic­u­lar situ­ation. Assets are the resources or items owned by a busi­ness entity or individual.

Company

Prop­erty, plant, equip­ment, and fixed assets are part of the long-term assets. The long-term assets or non-cur­rent assets include the items and resources that can­not be quickly con­ver­ted into cash. Besides, the cat­egor­iz­a­tion of advance rent in cur­rent and non-cur­rent assets is also sig­ni­fic­ant. There­fore, let’s answer the ques­tion by dif­fer­en­ti­at­ing between the cur­rent and non-cur­rent assets and cur­rent assets and liabilities.

Preparing Prepaid Rent Journal Entry

Cur­rent assets are assets that a com­pany plans to use or sell with­in a year; they are short-term assets. If any pre­paid expense will not be used with­in a year, then it must be recor­ded as a long-term asset. For example, assume Com­pany ABC pur­chases insur­ance for the upcom­ing 12-month peri­od. Com­pany ABC will ini­tially book the full $120,000 as a deb­it to pre­paid insur­ance, an asset on the bal­ance sheet, and a cred­it to cash.

Is Prepaid Rent A Current Asset?

They impact the present­a­tion of fin­an­cial state­ments, with deferred rent appear­ing as a liab­il­ity and pre­paid rent appear­ing as an asset. This pre­pay­ment is ini­tially recor­ded as an asset on the bal­ance sheet, reflect­ing the amount of rent paid ahead of time. Where­as the income for com­ing peri­ods will be over­stated since no rent expense is recor­ded. There­fore, it’s not fair as the income of the peri­od when cash is paid becomes under­stated due to outflow.

Pre­paid rent is a bal­ance sheet account, and rent expense is an income state­ment account. Pre­paid rent typ­ic­ally rep­res­ents mul­tiple rent pay­ments, while rent expense is a single rent pay­ment. So, a pre­paid account will always be rep­res­en­ted on the bal­ance sheet as an asset or a liab­il­ity. When the pre­paid is reduced, the expense is recor­ded on the income state­ment. Account­ing for pre­paid rent doesn’t have to be com­plic­ated, but it does require atten­tion at month-end-close.

Pre­paid assets, when man­aged prudently, can sig­ni­fic­antly influ­ence a company’s fin­an­cial state­ments. Ini­tially, these assets appear on the bal­ance sheet, bol­ster­ing the asset side. This tem­por­ary increase in assets can be advant­age­ous, par­tic­u­larly when com­pan­ies seek to enhance liquid­ity ratios such as the cur­rent ratio.

Amortization Schedule & Analysis

In con­clu­sion, account­ing for rent expense is chan­ging insig­ni­fic­antly from ASC 840 to ASC 842. Now if only the same thing could be said about the account­ing for oper­at­ing leases. When a com­pany pays rent in advance for a future peri­od, it has a pre­paid rent amount that rep­res­ents the right to use the leased prop­erty in the future. As time passes and the rent expense is incurred, the pre­paid rent is gradu­ally recog­nized as an expense, res­ult­ing in a reduc­tion of the pre­paid rent asset over time. Under ASC 842 base rent is included in the estab­lish­ment of the lease liab­il­ity and ROU asset.

In a basic gen­er­al ledger sys­tem, an account­ant or book­keep­er records a pre­paid asset to a bal­ance sheet account. This may require an adjust­ing entry to reclass rent expense to a pre­paid account. Going for­ward, a monthly entry will be booked to reduce the pre­paid expense account and record rent expense. While some account­ing sys­tems can auto­mate the amort­iz­a­tion of the pre­paid rent pay­ment, a review of the account should occur every account­ing peri­od. Pre­paid rent is rent that’s been paid in advance of the peri­od for which it’s due. Under ASC 842, the concept of pre­paid rent does not exist; how­ever, in prac­tice it is com­mon for less­ees to make rent pay­ments in advance.

Capital/Finance Lease vs. Operating Lease Explained: Differences, Accounting, & More

• In the grand sym­phony of fin­an­cial report­ing, the clas­si­fic­a­tion of pre­paid rent as an asset or liab­il­ity is not a stan­dalone note but a chord struck in har­mony with the broad­er context.
• There­fore, the entry on the liab­il­ity side is a deb­it to Lease Expense for $3,251 and a cred­it to Lease Liab­il­ity for the same amount.
• If it is non-refund­able, then it’s tech­nic­ally pre­paid rent, and this guide applies to the situation.
• Cred­it – What went out of the busi­ness Cash went out of the busi­ness to make the prepayment.
• Con­sist­ent with the match­ing prin­ciple of account­ing, when the rent peri­od does occur, the ten­ant will relieve the asset and record the expense.

Sim­il­arly to Year 2, the Year 3 “interest” com­pon­ent is cal­cu­lated by mul­tiply­ing the out­stand­ing lease bal­ance of $34,972 by the 5% dis­count rate, total­ing around $1,749. The lease liab­il­ity reduc­tion and the ROU asset amort­iz­a­tion are the dif­fer­ence between the pay­ment and the interest com­pon­ent, which is $34,972 ($36,721 pay­ment – $1,749 “Interest”). By apply­ing the present value (PV) for­mula or a PV cal­cu­lat­or, the PV of the remain­ing pay­ments is determ­ined to be $65,028. It is import­ant to note that in this cal­cu­la­tion, the first peri­od is accoun­ted as ‘zero’ in the annuity/cash flow.

Com­pan­ies make pre­pay­ments for goods or ser­vices, such as leased office equip­ment or insur­ance cov­er­age, that provide con­tinu­al bene­fits over time. Goods or ser­vices of this nature can­not be expensed imme­di­ately because the expense would not line up with the bene­fit incurred over time from using the asset. The “interest” com­pon­ent in Year 2 is cal­cu­lated by mul­tiply­ing the out­stand­ing lease bal­ance of $68,279 by the 5% dis­count rate, total­ing around $3,414. Pre­paid rent refers to pay­ments made by a less­ee for a lease peri­od that has not yet occurred. This advance pay­ment is com­mon in lease agree­ments and requires spe­cif­ic account­ing treatment.

The moment of trans­ition occurs when the ten­ant steps into the ren­ted domain, con­vert­ing the pre­paid rent from an asset into an expense. The cloak of anti­cip­a­tion is lif­ted, and the fin­an­cial bal­let takes a turn. As we already pre­paid the Year 1 rent, there won’t be a reduc­tion to lease liab­il­ity (remem­ber – the begin­ning lease liab­il­ity excluded that). To recap, we determ­ined the lease liab­il­ity to be $65,028 (PV of remain­ing pay­ment exclud­ing the pre­paid Year 1 rent).

Under­stand­ing the dif­fer­ences between pre­paid rent and rent expense is cru­cial for accur­ate fin­an­cial report­ing. Once the rent expense is due and incurred, the rent expense is recor­ded in the income state­ment of the respect­ive fin­an­cial year. We know that pre­paid rent rep­res­ents the amount of expense that will be due in future peri­ods. Non-cur­rent assets (long-term) and cur­rent assets (short-term) are cat­egor­ies of assets owned by an entity. The cur­rent assets are the short-term assets that can be quickly con­ver­ted into cash. As time pirou­ettes for­ward, the once-dormant asset begins its trans­form­a­tion, shed­ding its asset guise and reveal­ing its true nature.

Over time, the pre­paid asset’s value dimin­ishes as the related ser­vice or bene­fit is con­sumed. This pro­cess, known as amort­iz­a­tion, sys­tem­at­ic­ally alloc­ates the expense over the bene­fit peri­od. For instance, the afore­men­tioned main­ten­ance con­tract would decrease by $833.33 each month, gradu­ally shift­ing the cost from the asset account to an expense account.

The amort­iz­a­tion of the lease liab­il­ity and the depre­ci­ation of the ROU asset are com­bined to make up the straight-line lease expense. Sim­il­arly to ASC 840, this straight-line lease expense is cal­cu­lated as the sum of all of the rent pay­ments over the lease term and divided by the total num­ber of peri­ods. A full example with journ­al entries of account­ing for an oper­at­ing lease under ASC 842 can be found here. Keep in mind how­ever, rent or lease expenses are related to oper­at­ing leases only. This res­ults in a prob­lem with pre­paid expenses for the entit­ies fol­low­ing the accru­al sys­tem of account­ing. There­fore, busi­nesses must record the rent paid in advance on the company’s bal­ance sheet.

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