Understanding Prepaid Rent for ASC 842: What You Need to Know (2024)

FAQs

Understanding Prepaid Rent for ASC 842: What You Need to Know? ›

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.

Under ASC 840, prepaid rent was recorded as an asset. However, under ASC 842, the new lease accounting standard, prepaid rent is now included in the measurement of the ROU asset. Any prepaid rent outstanding as of the transition is included in the measurement of the ROU asset.

The initial journal entry for prepaid rent is a debit to prepaid rent and a credit to cash. These are both asset accounts and do not increase or decrease a company's balance sheet. Recall that prepaid expenses are considered an asset because they provide future economic benefits to the company.

Prepaid rent refers to lease payments made in advance for a future period. It represents an asset on the company's balance sheet, as the prepayment can be utilized to offset rent expenses in the future when it is incurred.

Prepaid vs Accrued Rent

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.

Adjustments for prepaid expenses

To do this, debit your Expense account and credit your Prepaid Expense account. This creates a prepaid expense adjusting entry. Let's say you prepay six month's worth of rent, which adds up to $6,000. When you prepay rent, you record the entire $6,000 as an asset on the balance sheet.

Prepaid Expense Journal Entry

Suppose Company A paid 6 months upfront for office rent worth $12,000. The journal entry in month 1 for this would be prepaid rent increasing by $12,000 as a debit, and cash decreasing by $12,000 as a credit.

Under the IRS 12-month rule, a taxpayer can deduct a prepaid expense in the current year if the rights or benefits for the taxpayer do not extend beyond the earlier of: 12 months after the right or benefit begins OR. The end of the tax year after the tax year in which payment is made.

But an important exception exists, called the "12-month rule." It lets you deduct a prepaid future expense in the current year if the expense is for a right or benefit that extends no longer than the earlier of: 12 months, or. until the end of the tax year after the tax year in which you made the payment.

When you pay rent in advance, here's how it affects the accounting equation: 1. **Assets (Cash/Prepaid Rent)**: Your cash balance decreases because you paid money, which is an asset. However, you also create an asset called "Prepaid Rent" to represent the portion of the rent you've paid for in advance.

Why is prepaid rent not an expense? ›

Prepaid expenses are classified as assets because they represent money that the company has not yet spent.

1. Securely satisfying a future need. This is probably the most important benefit of prepaying for expenses, since paying ahead of time gives you a desirable amount of security. For example, paying your rent on the first gives you peace of mind that your office space will be secure for the next month.

Prepaid expenses are considered a prepaid asset because the item that is paid for in advance, such as the rent or insurance coverage, has monetary value. Prepaid expenses are also considered a current asset because they can be easily liquidated—the value can be realized or converted to cash in one year or less.

However, ASC 842 aims to increase transparency for stakeholders by including a lease liability and corresponding ROU asset on the balance sheet for operating leases. Rent expense will still not be on the balance sheet.

Prepaid Rent as a Deferred Asset

It is deferred on the balance sheet until it is expensed on the income statement.

Amortization of prepaid expenses is an accounting process that calculates the incremental or periodic cost of a recurring expense that has been paid for in advance and applies the cost back to each of the individual accounting periods that benefit from the payment.

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.

In determining cash flows from investing activities, current assets such as inventory, accounts receivable, and prepaid rent are ignored because they relate to operating activities.

All intangible assets are nonphysical, but not all nonphysical assets are intangibles. For example, accounts receivable and prepaid expenses are nonphysical, yet classified as current assets rather than intangible assets.