If the lease term is less than one year, consider this a current investment because you expect it to be used or converted into cash within one year. Deferred revenue should be recorded as an asset and classified as a current asset if it is expected to be realized in the next 12 months. If it is not expected to be realized in the next 12 months, it should be classified as a long-term asset. Current assets play a vital role in evaluating a company’s short-term financial health. These are resources that the business expects to turn into cash or use up within the next year or an operating cycle, whichever is longer.
Nevertheless, the issue of whether this security deposit is refundable or non-refundable would determine how the prepaid rent is treated for bookkeeping purposes. The non-refundable prepaid rent that covers the rent for future months is carried on the books of the property’s owner as deferred unearned revenue. Whereas, on the books of the business renting the property, the prepaid rent recordings would be different. This amount would be recorded in the prepaid rent expense account which is capitalized or decreased when an amount of the prepaid rent is actually used up to pay for a month’s rent. If, for example, the space was used as a place to manufacture goods, the expense would then be listed as part of the cost of goods sold for the products produced.
Internal controls- common accounting issues for prepaid rent
In the case of the rent abatement above, the company begins paying rent but the payments are larger than the average rent expense which includes the abatement period. The expense for the first two months has been incurred because the company https://www.bookstime.com/articles/lifo-reserve has used the rented equipment or occupied the leased space, but cash for these services has not been paid. The company has recorded rent expense for the first two months of the quarter but they have an accrual for the payment.
For example, if a company has a significant amount of prepaid rent on its balance sheet, it can make it appear that they have more support than they do. It can mislead investors and other stakeholders is prepaid rent an asset who may evaluate the company’s financial health. One potential benefit is that it can improve a company’s liquidity position, as prepaid rent can be converted into cash if needed.
Common Reasons for Prepaid Expenses
On the balance sheet, the company’s assets, are grouped into current and fixed assets. Current assets are highly liquid and can be sold and converted easily into cash. It is found in the current asset account on the balance sheet that reports the amount of future rent expense that has been paid in advance of the rental period. Prepaid rent is therefore reported on the balance sheet as the amount that has not yet been used up or expired as of the balance sheet date. This lesson explains when prepaid expenses are incurred and offers examples of common prepaid expenses.
Even though a company makes a cash payment to the leasing company, the rent expense has not yet been incurred and therefore has to be recorded on the balance sheet as prepaid rent. Hence, prepaid rent is a current asset because the amount paid in advance can be used in the future to reduce rent expenses when incurred. Prepaid rent is recorded as an asset on the balance sheet and is initially recognized when you pay. As the period covered by the prepaid rent payment occurs, you decrease the prepaid rent asset account and increase the rent expense account. Accounting for prepaid rent doesn’t have to be complicated, but it does require attention at month-end-close. In a basic general ledger system, an accountant or bookkeeper records a prepaid asset to a balance sheet account.
AccountingTools
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 most of these cases, the transaction affected both sides of the accounting equation. Organizations can ensure they account for prepaid rent correctly by implementing steps and controls and adhering to the accounting principles and standards, such as GAAP or IFRS. Prepaid rent also provides tenants with financial stability, as they can budget their expenses knowing they have already paid for a certain period of rental occupancy.
