Lease payments decrease the lease liability and accrued interest of the lease liability. Recent updates to lease accounting, including new standards ASC 842, IFRS 16, GASB 87, and SFFAS 54, have changed the accounting treatment for some types of leasing arrangements. In short, organizations will now have to record both an asset and a liability for their operating leases. Under the old lease accounting rules, the cash payments for operating leases were recorded as rent expense in the period incurred and no impact to the balance sheet was recognized.
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Consider an example where the present value (PV) of lease payments, excluding the prepaid amount, is $8,000, and the prepaid rent is $2,000. In this case, the lease liability recognized is $8,000, and the Right-of-Use Asset balance totals $10,000 ($8,000 lease liability + $2,000 prepaid). This method of accounting for prepaid rent ensures that rent expense is recognized in the period when the office space is used, providing a more accurate view of StartCo’s financial performance. It aligns with the accrual basis of accounting and the matching principle. Prepaid rent accounting helps a company match its rent expenses with the periods they benefit, providing a more accurate view of the company’s financial performance. After his journal entry, the balance of prepaid rent will become zero ($5,000 – $2,500 – $2,500) while rent expense increases to $5,000 ($2,500 in January + $2,500 in February).
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Subsequent lease accounting under ASC 842 also requires any prepaid amounts to be recorded to the ROU asset. Consistent with the matching principle of accounting, when the rent period does occur, the tenant will relieve the asset and record the expense. A typical scenario with prepaid rent is mailing the rent check early so the landlord receives it by the due date. The periodic lease expense for an operating lease under ASC 842 is the product of the total cash payments due for a lease contract divided by the total number of periods in the lease term. If all details of a contract are the same, organizations record the same amount for lease expense under ASC 842 as they would for rent expense under ASC 840. By applying the present value (PV) formula or a PV calculator, the PV of the remaining payments is determined to be $65,028.
Rent Accounting for ASC 842: Prepaid Rent, Journal Entries, and More
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 prepaid rent account 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. Keep in mind however, rent or lease expenses are related to operating leases only. Both rent expense and lease expense represent the periodic payment made for the use of the underlying asset. Organizations may have a commercial leasing arrangement or a rental agreement.
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Recording Prepaid Expenses
The matching principle in accounting requires that expenses be matched with revenues in the period in which they are incurred. Prepaid rent is amortized over the period it covers, ensuring that rent expense is recognized in the same period that the rental space is used. Prepaying rent is a common practice for businesses, especially when securing long-term leases or wanting to take advantage of discounted rates. However, accurately accounting for prepaid rent is crucial for maintaining accurate financial records and reflecting the true cost of your business operations. Similar to the treatment of prepaid rent, under ASC 842 the accruals are recorded to the ROU asset instead of a separate accrued rent account. The key question here is whether this “security deposit” is refundable.
- The corresponding journal entry each month would be a debit to rent expense for $1,000 and a credit to prepaid rent for the same amount.
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- Examples of prepaid expenses include rent, insurance, subscriptions, licenses, and taxes.
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- Prepaid rent can be considered a deferred asset because it represents a cost that has been paid in advance and will be incurred as an expense in a future period.
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