When rent is paid in advance, the accrual accounting concept requires that only the portion of the rent incurred should be expenses monthly. What do we mean by rent paid in advance? What's the journal entries? And how is it treated in the balance sheet? These are what will be discussed under this section of Question Asked.
1. What's the rent paid in advance?
This is the rent paid to a landlord ahead of the rental period. To illustrate, if the rent is for 12 months (say, January to December) and the rent is paid in January, it means that it was paid in advance of the periods. Normally, the rent should be paid monthly so as to match the monthly rent with the income earned for that month. For paying the rent ahead, it implies that an adjustment must be done to ensure that only the monthly rent is matched to the income.
The accrual and matching concept affects rent paid in advance transaction. According to the principle guiding accrual concept, rent is recognized when it is earned and not necessarily when it was paid. On the other hand, the matching principle stresses that expenses must be matched with revenue in the period to which they relate.
Therefore, the rent paid cannot be recognized fully in the month of payment. For example, if 12 million was paid in January for a 12 month period. According to the above concepts, the 12 million is not posted as expenses for the month of January. Instead, it will be spread over the 12 months. That is, 1 million will be recognized as rent expenses on a monthly basis from January to December.
Another name for rent paid in advance is rent prepaid or rent prepayment. When the payment is made, it is posted to the rent prepaid account. Then on a monthly basis, an amortized amount is deducted from the prepayment account to the expense account.
2. Rent prepaid journal entry
The journal entry is stated below:
When the rent is paid
- Dr: Rent prepaid account
- Cr: Bank account
With the total rent amount paid
Monthly recognition of rent expenses
- Dr: Rent expenses account
- Cr: Rent prepaid a/c
With the monthly amortized charges
2.1 Example
Alex enterprise rented a building for its official activities. The building cost 24 million Naira per annum starting from May 1st. Alex enterprise management paid for 2023 rent on April 27, 2023 from its Zenith bank.. Show the complete double entry for this transaction.
2.2 Solution
When the rent was paid in April, 2023
- Dr: Rent Prepaid a/c
- Cr: Zenith bank a/c
With the sum of 24 million Naira.
On a monthly basis, starting from May 2023 to April 2024
- Dr: Rent a/c
- Cr: Rent prepaid a/c
With the monthly proportion of 2 million Naira (that is, 24 million divided by 12 months).
Recognition to the P/L account
- Dr: P/L account
- Cr: Rent account
With 2 million Naira to recognize the monthly expenses.
3. Rent paid in advance and balance sheet
In the statement of financial position, the question is: how do we treat rent prepaid? The balance sheet contains the assets, liability and equity of the entity. Therefore, is rent prepaid and asset, liability, or capital? The answer is not far-fetched. In our knowledge of double entry rules, assets are debited and liabilities and equity are credited. The rent prepaid treatment above shows that when it arises, a debit entry is passed. Therefore, in the balance sheet it is an asset account. Specifically, it is posted under the current assets section as “other current assets” or “prepayment” line item.
4. Conclusion
In final words, rent paid in advance or rent prepaid is an asset account. It occurs when rent is paid ahead of the periods it is incurred. When this transaction happens debit is passed to the rent prepaid account while a credit is done on the respective bank account.
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