Prepaid Rent Journal Entry Example

Whenever prepaid rent is paid in cash it decreases the cash in hand balance. Likewise, the journal entry here doesn’t involve an income statement account as both prepaid rent and cash are balance sheet items. Hence, the journal entry above is simply increasing one asset (prepaid rent) together with the decreasing of another asset (cash). However, similar to prepaid insurance, the prepaid rent will expire through the passage of time. So, the company needs to recognize the expiration cost as a rent expense at the end of the period.

If the entirety of the prepaid asset is to be consumed within 12 months, then it is deemed a current asset. However, it is not uncommon to see contracts spanning multiple years, being paid in advance. In these scenarios the portion of the prepaid obligation which exceeds 12 months is recognized as a long-term or noncurrent asset. In most cases, this is the correct entry to book, however, in certain transactions we are paying upfront for the right to use an asset or receive a service over a defined period of time.

What are Prepaid Expenses?

Likewise, if the company doesn’t account for rent expense by reducing prepaid rent as in the above journal entry, the company’s total assets will be overstated while the total expenses will be understated. As previously stated, a prepaid can be listed as an asset or a liability on the balance sheet. When reviewing this line item, it’s important to substantiate the balance with source documents.

  • Going forward, a monthly entry will be booked to reduce the prepaid expense account and record rent expense.
  • Rather, any prepaid rent pertaining to a long-term lease would be rolled into the ROU asset balance recognized on the balance sheet.
  • Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
  • That is why the company needs to make the January 31 adjusting entry above by increasing $2,500 in an expense account (rent expense) and decreasing $2,500 in an asset account (prepaid rent).

From an accounting perspective, rent can be defined as an expense or a cost of occupying/utilizing a property for a specific period. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI's full course catalog and accredited Certification Programs. An additional 610,000 students from low-income backgrounds are expected to qualify for the Pell Grant, which gives students up to $7,395 that doesn’t need to be repaid. You may want to set up an amortization table to track the decrease in the account over the policy term and to determine what the journal entries will be. An adjusting entry for the portion actually being applied at the end of each month.


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Balance Sheet

Like a cash account, the bank account will also be treated as a current asset. Whenever prepaid rent is paid by cheque it decreases the bank balance of the entity. Considering the rules of accounting, a decrease in the asset is always credited. When an advance payment for the rent is made by the entity, the prepaid rent account is debited and the bank account is credited. The adjusting journal entry is done each month, and at the end of the year, when the lease agreement has no future economic benefits, the prepaid rent balance would be 0.

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The long-term subscription prepaid represents the value of the subscription paid for in advance beyond 12 months and is amortized at the beginning of the subscription term. The proceeding amortization schedule illustrates the appropriate amortization of the short-term and long-term portions of the prepaid subscription. The accounting treatment for prepaid rent can be understood from two perspectives. In this case the asset (pre paid rent) has been reduced by 1,000 and the income statement has a rent expense of 1,000. The expense in the income statement reduces the net income which reduces the retained earnings and therefore the owners equity in the business.

Accounting Ratios

While some accounting systems can automate the amortization of the prepaid rent payment, a review of the account should occur every accounting period. Although being a simple concept, it is important for an organization to correctly account for and recognize prepaid expenses on its balance sheet. Prepaid assets typically fall in the current asset bucket and therefore impact key financial ratios. Additionally, an organization reporting under US GAAP must follow the matching principle by recognizing expenses in the period in which they are incurred. This requires proper calculation and amortization of prepaid expenditures such as insurance, software subscriptions, and leases.

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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. ABC & Co. has paid rent accounting for $2,000 in advance (prepaid) for 5 months.

In layman’s terms, prepaid expense is recognized on the income statement once the value of the good or service is realized, i.e, the service or good is delivered. As now the expense has been incurred, the rent expense account will be debited. When an advance payment for the rent is made by the entity, the prepaid rent account is debited and the cash account is credited as mentioned in the example earlier. Rent is treated usually as an expense but in this scenario, it is an asset. Likewise, without the adjusting entry above, assets are overstated and expenses are understated by the same amount of $2,500 as at January 31, 201.

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