When you have a lease agreement, lessees and lessors usually decide upon dates for when payments are due. Whether it’s a lease or a different type of asset, there’s a set date due date for payments made to the lessor. But what happens when a lessee pays early? How does this affect the balance sheet and your journal entries? 

In this blog, we will go through what happens in the case of prepaid rent or expenses, how they affect lease accounting, and dive into other areas related to prepaid expenses, such as assets and recognition, amortization, software subscriptions, and more.

But first—let’s set some definitions straight.

What are Prepaid Expenses?

A prepaid expense is an expense that’s been paid prior to its due date. Prepaid expenses are recorded on the balance sheet as an asset account and moved to expense for the period in which it’s incurred. Prepaid rent may be part of the ROU asset on an organization’s balance sheet because rent was paid at or before commencement of a lease.

Prepaid Rent 

Prepaid rent is a form of prepaid expense. More specifically, it’s rent that has been paid in advance of the period for which it’s due. Under ASC 842, the concept of prepaid rent doesn’t exist. In practice, prepaid rent may occur when lessees make rent payments in advance of the payment due date.

Prepaid vs Accrued Rent 

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. Accrued rent is a liability on the Balance Sheet and is reversed when paid or when an invoice is posted. Whereas prepaid rent is rent that’s been paid ahead of the date by which it is due, accrued rent is rent that has not been paid to the lessor by the lessee before or on the agreed upon date. 

Make Sure Your Organization Has Transitioned and is Operating Under the New Rules for ASC 842 

It is of paramount importance to ensure that your organization has transitioned to the new lease accounting standard and is operating fully under the ASC 842 standard of lease accounting. Want to learn more about transition leases and what to do about them? Read more here.

Prepaid Expenses on the Balance Sheet

So what does a prepaid expense look like on the balance sheet? How does it change your lease accounting?

When rent is paid just a few days early, it may not need to be recorded as prepaid rent. It will clear itself out when the lease payment is posted in the next few days, so there’s no need to change your accounting practices to accommodate it. However, when a large sum of rent payments are paid in advance, it results in a remeasurement event. This case calls for a remeasurement because when lease liability is calculated, it is considered to be the present value of future payments. But if a lessee pays, for example, an entire year’s worth of lease payments at the beginning of a year, there are no future payments, therefore the Lease Liability needs to be re-measured.

When Do Prepaid Expenses Hit the Income Statement?

Prepaid expenses are reclassified to the income statement in the period which they are incurred. So under ASC 840, prepaid rent would hit the income statement in the period which it is incurred.

Other Payment Types

Fixed and Variable Lease Payments

Fixed lease payments are payments that are documented in lease contracts. Fixed payments may increase over the term of a lease. On the other hand, variable lease payments are those made for the right to use an asset. They vary due to changes in facts or circumstances that occur after commencement of the lease. Both are fundamentally different from prepaid expenses and are accounted for separately.

Assets and Recognition

There may be scenarios that arise when accounting for leases under ASC 842 that require specific clarification. Below is one of these scenarios. 

What Criteria Determine Whether a Prepaid Asset is Classified as a Current Asset or a Noncurrent Asset?

Current assets are cash or other assets expected to be consumed in one year or within the operating cycle, whichever is longer (12 months is the usual time frame for an operating cycle). Noncurrent assets are anything that is not current or held longer than 12 months.

Prepaid Expenses, Amortization, and Journal Entries

What Considerations are Important When Accounting for Prepaid Software Subscriptions, and How is Amortization Handled?

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.

Prepaid Expenses and Lease Types

Prepaid Expenses and Commercial Leases

The general concepts of prepaid expenses and how to account for them are the same regardless of the type of lease for which you’re accounting.  Commercial leases for real estate may have specific clauses about when rent is due, but that’s about it for special circumstances that would affect prepaid expenses.

Prepaid Expenses and Lease Incentives

Prepaid expenses and how they affect a lease depends more on how a lease is written than whether or not it is a commercial lease or has a lease incentive as a part of the contract. This goes for lease incentives as well. 

Our advice is to focus less on whether your lease is commercial or if you have a lease incentive written into your contract, and more on how your lease is written in order to account properly for prepaid expenses in your lease accounting.

Still Have Questions About Prepaid Expenses?

LeaseCrunch has a team full of CPAs, former FASB staff, and Big Four public accounting auditors ready to answer your toughest lease accounting questions. Don’t hesitate to contact us here with any questions you may have.

If you’re interested in foregoing fully manual lease accounting and investing in software that automates part of the process for you, reach out for a demo of our award-winning lease accounting software. Used by over 175 of the Top 400 CPA firms, our software helps rid your lease accounting of errors while ensuring compliance with the latest standards.

FAQs

Is a Prepaid Expense an Asset?

Prepaid expenses are recorded as assets on the Balance Sheet.

Is Prepaid Insurance an Asset?

Yes it is.

Are prepaid assets and prepaid rent the same?

It is a matter of categories. Prepaid rent is a type of prepaid asset. Both prepaid rent and prepaid assets in general are included on the Balance Sheet.