Rent payable definition, explanation, journal entry, example

A company makes a cash payment, but the rent expense has not yet been incurred so the company has prepaid rent to record. Prepaid rent is an asset – the prepaid amount can be used by the entity in the future to reduce rent expense when incurred in the future. ABC & Co. has paid rent accounting for $2,000 in advance (prepaid) for 5 months. The cash account will be credited (reduced) and the prepaid rent account will be debited (increased) by $2,000.

Renting and leasing agreements have existed for a long time and will continue to exist for individuals and businesses. With the transition to ASC 842 under US GAAP, some of the terminology and accounting treatments related to rent expense are changing. If the lease agreement defines the rent payments as contingent upon a performance login or create an account or usage but also includes a minimum threshold, the minimum is used in the calculation of the lease liability. Because of the inclusion of the minimum threshold, the lessee has a commitment to pay at least the lower amount regardless of actual performance or usage. These types of payment terms are known as in-substance fixed rent.

Accounting Treatment for Prepaid Rent

The adjusting journal entry is done each month, and at the end of the year, when the insurance policy has no future economic benefits, the prepaid insurance balance would be 0. The use of the building also affects whether the rent expense will be classified as operating cost or production cost. Manufacturing companies generally record rent expense as production cost since the payment usually covers for the space used in the production of goods. Service providers such as car repair shops record their rent expense as operating cost since it covers for the space where they provide services to their customers. Companies that offer both products and services split the rent expense between the production cost and operating cost to cover for the various activities. Using the cash basis of accounting, rent expense is the amount of cash that the company spends on rent within the stipulated accounting period.

Rent, Commission paid, Salaries & Wages Paid, Interest paid, etc are some examples of Expenses. The Cash Account will be decreased with the amount paid as expenses, so it will be credited and Expenses will be debited according to the rule of the Nominal account. The second entry is to amortize prepaid assets to prepaid expenses when rent is actually consumed. From an accounting perspective, rent can be defined as an expense or a cost of occupying/utilizing a property for a specific period. Similar to fixed rents, the minimum rent is also included in the straight-line rent calculation for operating leases under ASC 840 and the calculation of the lease liability under ASC 842.

Rent Paid Journal entry:

Rent expense is reported within the accounting period in which the rent was paid. Rent expenses can be classified as production costs or administrative costs. If the building is used for other daily business operations, the rent expense will be classified as an administrative expense. Keep in mind however, rent or lease expenses are related to operating leases only.

The debit increases the receivables account, which is an asset that shows money your tenant owes. For example, assume a tenant pays your small business $4,000 on the fifth day of each month for the previous month‘s rent. At the end of the month, debit $4,000 to rent receivable and credit $4,000 to rent income in your general ledger.

Rent paid in Advance in Trial Balance

Hit company pays the Security deposit now and will get that as a refund at the end of rental tenure. So, the Security deposit is receivable, and Cash from Bank will be paid. An adjusting entry for the portion actually being applied at the end of each month. LMN & Co. will record the full amount as an expense at the beginning of the rental period.

• However, you are recording the straight-line rent expense calculated by dividing the total amount of required rent payments by the number of periods in the lease term.
• Following are the steps for recording the journal entry for rent paid by cheque.
• The accounting treatment for prepaid rent can be understood from two perspectives.
• A company’s payment of each month’s rent reduces the company’s asset Cash.
• On January 1st, 2022, XYZ Co. will record the first aspect of the accounting treatment i.e. when advance payment is made to increase the expense account and decrease the asset account as discussed earlier.
• If the rent expense is ancillary to the functioning of the business, then it’s an indirect expense.

Rent expense offsets the income of a company and is generally not tax deductible. For example, on December 31, we have paid a $5,000 rent deposit in advance to the landlord in order to rent the office space for our business operation. This $5,000 will be refunded back to us when we stop renting this office space. If the adjusting entry had debited Prepaid Rent, it had credited also Rent Expense, which means that… On December 31, 2020, Hannifin must report in its balance sheet the rent payable of $2,500 as current liability.

Example of rent expense as a debit and not a credit

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. In other words, as a tenant, we will not pay the last month of the rent, for we can use the rent deposit to offset our rent payment for the last month. Of course, this journal entry is assuming that there is no breach of the rent agreement such as stopping renting the property before the end of the rent agreement.

On the other hand, an adjusting entry will be made each month for the portion actually being applied at the end of each month. XYZ & Co. will record the full amount as an expense at the beginning of the rental period. When the periodic payments are structured so they can not be calculated without the occurrence of an event, such as a number of sales or units produced, the payments are not considered fixed rent.

Accounting for prepaid rent with journal entries

Whenever prepaid rent is paid in cash it decreases the cash in hand balance. After the cost of goods sold, it is one of the significant expenses for organizations of any size and nature. Either in accrual or cash-based accounting system, when rent is paid in advance (usually due on the first of each month) it is considered prepaid rent. Accruals represent an obligation for an expense incurred but not paid. In the case of a rent accrual, the company records the rent expense but the payment is not yet due.

Then, when we actually owe our first month of rent, we would debit rent expense for $100 and credit prepaid rent. The credit to prepaid rent reduces the asset since we needed to record the expense. The same entry would be recorded for the next 6 months until prepaid rent was $0. Prepaid rent is a current asset (unless you prepay for more than 12 months of future rent) and it occurs when the company pays cash for future rent. Since they have not yet incurred the rent expense, the company should record an asset as they will be able to benefit in the future.