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

The non-government sector of accounting does not have a special rule for software subscriptions. This type of lease accounting is covered by Topic 350, which details intangibles, goodwill, and other types of lease accounting cases. Below is a break down of subject weightings in the FMVA® financial analyst program.

Prepaid Rent and Other Rent Accounting for ASC 842 Explained (Base, Accrued, Contingent, and Deferred)

These are both asset accounts and do not increase or decrease a company’s balance sheet. Recall that prepaid expenses are considered an asset because they provide future economic benefits to the company. Within the cash flow statement, prepaid rent has a distinct role, primarily affecting the operating activities section. This financial document delineates the cash inflows and outflows from core business operations, investing activities, and financing activities.

Monthly Amortization Entries

Since a payment is made, the lease liability prepaid rent accounting reduction amount is the difference between the lease payment and this interest component, which is $33,307 ($36,721 payment – $3,414 “Interest”). To recap, we determined the lease liability to be $65,028 (PV of remaining payment excluding the prepaid Year 1 rent). We then add the prepaid amount of $36,721 to establish the Right-of-use (ROU) Asset balance, which comes out to be $101,749. If it is non-refundable, then it’s technically prepaid rent, and this guide applies to the situation. If it is refundable at the end of the lease, then it’s not prepaid rent and should be regarded simply as a balance sheet item.

Prepaid Expenses: Definition

• However, under ASC 842, the new lease accounting standard, prepaid rent is now included in the measurement of the ROU asset.
• Hence, the journal entry above is simply increasing one asset (prepaid rent) together with the decreasing of another asset (cash).
• They pay the lessor three months in advance on the first day of every quarter.
• The treatment of prepaid rent can influence how stakeholders view a company’s financial health.
• Note that for each date in the above example, the sum of entries under the “Assets” heading is equal to the sum of entries under the “Liabilities + Owner’s Equity” heading.
• In conclusion, accounting for rent expense is changing insignificantly from ASC 840 to ASC 842.

The income statement, on the other hand, captures the systematic allocation of prepaid rent as an expense. This allocation is spread over the rental period to which the prepayment relates, ensuring that each reporting period reflects the true cost of operations. The consistent treatment of prepaid rent in the income statement provides stakeholders with a realistic view of the company’s operating expenses and profitability.

Reporting Prepaid Rent in Financial Statements

Prepaid rent is the amount the company pays in advance to use the rental facility (e.g. office or equipemnt, etc.). Hence, the company needs to properly make the prepaid rent journal entry to avoid the error that leads to misstatement due to prepaid rent is not appropriately recognized in accounting. Consider an example where the present value (PV) of lease payments, excluding the prepaid amount, is $8,000, and the prepaid rent is $2,000. In this case, the lease liability recognized is $8,000, and the Right-of-Use Asset balance totals $10,000 ($8,000 lease liability + $2,000 prepaid). Similar to the treatment of prepaid rent, under ASC 842 the accruals are recorded to the ROU asset instead of a separate accrued rent account. After his journal entry, the balance of prepaid rent will become zero ($5,000 – $2,500 – $2,500) while rent expense increases to $5,000 ($2,500 in January + $2,500 in February).

Effect of Prepaid Expenses on Financial Statements

In this case, the difference is a loss of $175, so the owner’s equity has decreased from $7500 at the beginning of the month to $7325 at the end of the month. Every month must be listed under the original monthly rental expense, regardless of what was actually paid that month. Thus, a rent payment made under the cash basis would be recorded as an expense in the period in which the expenditure was made, irrespective of the period to which the rent payment relates. Under ASC 842, you would see the same entries, but the prepaid rent would be recorded to the ROU asset in place of a separate prepaid rent account. Generally, variable, or contingent rent, is expensed as incurred according to both legacy accounting and the new accounting standard.

An example of accounting for variable/contingent rent

• 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”).
• Accrued rent occurs when rent has not yet been paid or an invoice hasn’t been processed and the organization needs to record the expense.
• At the end of the year, there may be expenses whose benefits have been received but not paid for and expenses that may have been paid, but their benefit will appear in the next financial year.
• A typical scenario with prepaid rent is mailing the rent check early so the landlord receives it by the due date.
• Organizations may have a commercial leasing arrangement or a rental agreement.

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. Additionally, at the time of transition to ASC 842, any outstanding prepaid rent amounts would be included in the calculation of the appropriate ROU asset.

However, from the landlord’s perspective, the prepaid amount represents a liability until the rental period occurs. Prepaid insurance is insurance paid in advance and that has not yet expired on the date of the balance sheet. The entry on the liability side is a debit to Lease Expense for $3,414, a debit to Lease Liability for $33,307, and a credit to Cash or AP for $36,721 to record the payment. The entry for the ROU asset is a debit to Lease Expense for $33,307 and a credit to Right-of-use (ROU) Asset for the same amount to record the amortization. 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.

For example, let’s examine a lease agreement that includes a variable rent portion of a percentage of sales over an annual minimum. At the initial measurement and recognition of the lease, the company is unsure if or when the minimum threshold will be exceeded. Therefore the variable portion of the rent payment is not included in the initial calculations, only expensed in the period paid.