Getting paid ahead of time or paying in advance is always a perk.

But for lease accounting, it can make things a little more difficult. Prepaid rent is rent that’s been paid in advance of the period for which it’s due. Under ASC 842, the concept of prepaid rent does not exist; however, in practice it is common for lessees to make rent payments in advance. This means that paying attention to when prepaid rent is paid and ensuring it’s recorded correctly is of paramount importance. 

Keep reading to learn all about prepaid rent, whether it’s considered an asset, and how to record prepaid rent.

Is Prepaid Rent Considered an Asset, and What Accounting Standards Govern its Treatment?

Prepaid rent is governed by the ASC 842 rules of lease accounting. Under ASC 842, prepaid rent is now included in the ROU asset instead of being accounted for in a separate Balance Sheet account. If the lessee’s organization decides to make a payment before it’s due, there may continue to be an outstanding balance in the clearing account until the lease accounting entries catch up. Oftentimes, this entry should not be adjusted in lease accounting software and will clear itself up in the following month. 

When an organization makes a large payment that covers several months, it could be considered a remeasurement of the Lease Liability and ROU Asset and should be accounted for as such.

How is Prepaid Rent Recorded, and Why is Timing a Crucial Factor in Recognizing It?

Prepaid rent was recorded under the old accounting standard in a number of steps that are listed below:

1. Set up accounts - The lessor should set up a different account for prepaid rent to avoid errors in tracking and classification.
2. Record initial payment - When a lessee pays their rent, record it by debiting the account set up for prepaid rent and crediting your cash/bank account.
3. Determine amortization schedule - Using the straight-line method of amortization, determine the monthly rent expense.
4. Record monthly rent expense - Record the monthly expense by debiting the expense account and crediting the prepaid rent account
5. Monitor and adjust - Make sure to review the prepaid rent account regularly to ensure accuracy.

Timing is a crucial factor in recognizing prepaid rent because the lessee pays the lessor and the lessor receives payment outside of the time period for which the payment is made.

Prepaid Rent Journal Entries

Under the previous accounting standard, ASC 840, accounting for prepaid rent would look like the example below. Here is an example of what that prepaid rent journal entry would look like:

A lessee’s rent annually is $24,000. They pay the lessor three months in advance on the first day of every quarter. On the 1 of January they pay an advance of $6,000 to cover the first three months of the year. This means their Prepaid Rent is $6,000.

The the prepaid rent is recorded as follows:

• The payment of cash that created the prepayment on the 1st of January is shown as a credit to cash
• The payment is recorded as a debit to Prepaid Rent of $6,000 on January 1.

To record the prepaid rent payment, the lessee will book an entry to record the payment:

Account             Debit             Credit

Prepaid rent       $6,000

Cash                                            $6,000

Total                  $6,000          $6,000

At the end of January, ⅓ of the rent expense ($2,000) will be used up as the rent payment for that month. The rent payment is calculated as such:

Period of rent payment - 3 months

Amount paid - $6,000

Period for which rent is expensed  - 1 month

Rent prepayment for the period = $6,000 x ⅓ = $2,000, or $6,000 / 3 = $2,000

To record the expense for January, the lessee must reduce the Prepaid Rent account as follows:

Account             Debit             Credit

Rent Expense    $2,000

Prepaid rent                               $2,000

Total                   $2,000            $2,000 

It is important to note that the above referenced entries are how Prepaid Rent was accounted for under ASC 840. The concepts of Prepaid Rent are no longer recorded under ASC 842 as the payments are recorded as part of the ROU Asset.

How Has the Accounting Treatment of Prepaid Rent Changed Under ASC 842?

Under ASC 842, the concept of prepaid rent goes away. When accounting for leases under the new standard,  the lessee first determines the future payments. Once the future payments have been identified, determine the Present Value of each payment using the Discount Rate. This becomes the Lease Liability. 

Furthermore, under ASC 842, prepaid rent is now accounted for as a part of the ROU asset instead of as a separate entry.

What is Deferred Rent, and When is it Recognized as a Liability?

Under ASC 842, deferred rent is also a concept that no longer exists. 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. 

Free rent during a lease is called an abatement and is accounted for as no lease payment under ASC 842. 

Deferred rent is a liability (or an asset) that results from the difference between the actual payment to the lessor and the straight-line expense recorded on the lessee’s statements. At transition to ASC 842, deferred rent is included as part of the ROU Asset balance. After transition to ASC 842, deferred rent is no longer recorded.

Lease Accounting Software for Prepaid Rent and More

Looking for an easier way to account for prepaid rent than spreadsheets? Our lease accounting software automates the majority of the lease accounting process, making this complicated necessity quicker, more accurate, and more compliant.

Furthermore, we have a stellar customer service team who would be more than willing to answer any questions you may have either right now, or further down the line. Reach out today for a free demo or just to chat.

FAQs

Is prepaid rent a current asset?

Under ASC 842, the concept of prepaid rent goes away. In some cases when lessee’s make large payments in advance, a remeasurement of the Lease Liability may be necessary.