Overview of Prepaid Rent Accounting
Prepaid rent is rent paid prior to the rental period to which it relates, so the tenant should record on the balance sheet the amount of rent paid that has not yet been used.
Rent is commonly paid in advance, being due on the first day of that month covered by the rent payment. The landlord typically sends an invoice several weeks early, so the tenant issues a check payment at the end of the preceding month in order to mail it to the landlord and have it arrive by the due date. This presents a problem for the tenant, since the payment would normally appear in its income statement as rent expense in the period in which the invoice was entered in the accounting software – however, since the payment was recorded and the check was cut in the month before the period to which the payment relates, it is actually prepaid rent.
Example of Prepaid Rent Accounting
The proper way to account for prepaid rent is to record the initial payment in the prepaid assets (or prepaid rent) account, using this entry:
Then, when the check is cut, the accounting software records this entry:
Finally, the tenant records the following entry sometime during the month to which the rent payment actually applies, which finally charges the payment to expense:
In short, store a prepaid rent payment on the balance sheet as an asset until the month when the company is actually using the facility to which the rent relates, and then charge it to expense.
A concern when recording prepaid rent in this manner is that one might forget to shift the asset into an expense account in the month when rent is consumed. If so, the financial statements under-report the expense and over-report the asset. To avoid this, keep track of the contents of the prepaid assets account, and review the list prior to closing the books at the end of each month.
The accounting treatment is different under the cash basis of accounting, where expenses are only recorded when payment is issued. 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.