Prepaid expenses are common in any business. Some of these prepaid expenses include leases, monthly rent including first month’s rent, security deposits or advance rent, insurance policies with prepaid insurance or any other prepaid insurance expense. Let’s zone in on rent. When rent is paid upfront under accrual accounting vs cash basis, it is considered prepaid rent and is recorded on the entities’ balance sheet. Whether the prepaid is recorded as an asset or liability is dependent on the nature of the transaction. Below are important features of prepaid rent and how it’s accounted for. Efficient accounting records are essential for the current accounting period, year end and the next accounting period or following year.

Prepaid Rent & Accounting

Accounting for prepaid rent doesn’t have to be complicated, but it does require attention at month-end-close. 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: Asset Or Liability

Prepaid rent is recorded as an asset when an organization makes a prepayment of rent to a landlord or a third-party. A liability is recorded when a company receives a prepayment of rent from a tenant or a third-party. It is important for accountants, business owners and managers to understand this distinction. Failure to classify prepaids accurately on the balance sheet can lead to material misstatements of financial information and poor business decision-making.

Prepaid Rent Vs. Rent Expense

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. While prepaids and expenses are related, they are distinctly different.

Example Of Prepaid Rent Accounting

A corporation pays its rent for 6 months in advance. Cash is credited and reduced on the balance sheet. A prepaid rent asset account is debited for the same amount. As each month passes, one rent payment is credited from the prepaid rent asset account, and a debit is made to the rent expense account. This process is repeated as many times as necessary to recognize rent expense in the proper accounting period.

Prepaid Rent On The Balance Sheet

As previously stated, a prepaid can be listed as an asset or a liability on the balance sheet. It is often considered a current asset or liability. When reviewing this line item, it’s important to substantiate the balance with source documents. This could include bank statements, billing statements and other documentation, to assure the advance payment balance is complete and accurate.

Preparing Prepaid Rent Journal Entry

Recording Prepaid Asset

Credit – Cash
Debit – Prepaid Expense

Amortizing The Prepaid Expense

Credit – Prepaid Expense
Debit – Rent Expense

Prepaid rent is an important expense account to understand on the balance sheet. Whether it is an asset or liability depends on the party remitting payment and the one receiving it. Proper recording and amortization of prepaids is important for producing accurate, reliable financial statements.

Resources:

Auditing Prepaid Expenses and Deferred Charges