Published in: Accounting

Is Prepaid Rent an Asset?

Author Obotu Agape Oguche

Published on: October 17, 2022

Is prepaid rent an asset? A company can make an advance payment for a good or service such as rent for leased office space or insurance coverage that gives continual benefits over time. Such prepayments are known as prepaid expenses which are made in advance for future benefits. Hence, prepaid rent is the payment of rent that is made before the rental period to which it is related. Recording a prepaid rent could be a bit of a hassle because this payment is recorded and the check is cut in the month that is before the period to which the payment relates.

In accounting, prepaid expenses are recorded on the balance sheet as assets. Therefore, prepaid rent would be recorded on the balance sheet as the amount of rent that has been paid but has not yet been used. Is prepaid rent an asset; being that it is an amount of rent that has been paid but not yet used?

In this article, we will discuss prepaid rent and assets to decipher if prepaid rent should be considered an asset and why. First, let’s have an understanding of prepaid rent.

Related: Is unearned revenue an asset?

In order to meet tax and other regulatory obligations, all businesses must maintain bookkeeping records. Periodically, businesses make a set of financial statements to summarize their financial position that has to conform to a set of generally accepted accounting principles that standardize financial reporting, for comparison to other businesses.

Usually, when a company enters into a rental agreement to lease a property, it has to pay not only the rent for the current month but also pay the rent for a certain number of months in advance as security for performance under the agreement. Then, this security deposit upon the satisfaction of certain conditions can be refundable at the end of the lease. Alternatively, this security can also be treated as a nonrefundable advance payment that covers the months at the tail end of the agreement.

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.

The advance payment of rent can apply to months that are years in the future. Therefore, until the amount of prepayment is actually used up in payment for a month’s use of the leased property, it must be properly recorded as a current asset on the company’s balance sheet. The prepaid rent account on the balance sheet allows the business to show that it has a current asset that will benefit the business in the future.

Furthermore, the accounting treatment for prepaid rent is different under the cash basis accounting. In the cash basis accounting method, expenses such as rent expense are only recorded when payment is issued. Therefore, a rent payment made under the cash basis accounting would be recorded as an expense in the period in which the expenditure was made, regardless of the period to which the rent payment relates.

An example of prepaid rent in accounting

Assume Company XYZ is renting an office space and decides to make a six months advance payment to the landlord. Say the company pays a total of $30,000 for six months. This $30,000 that has been paid is prepaid rent and the initial journal entry for this will be as follows:

As each month ends, the prepaid rent on the balance sheet is reduced by the monthly rent amount, which is $5,000 per month (i.e $30,000/6 months). As a result, the company would recognize a rental expense of $5,000 on the income statement. Hence, the monthly adjusting entry would be as follows:

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Asset on the balance sheet

Assets, liabilities and equity are the major accounts that are reported on the balance sheet. An asset is anything of value or a resource with economic value that the company owns or controls with the expectation that it will provide a future benefit. It could be owned by an individual, corporation, or country with the expectation that it will yield future benefits. On a company’s balance sheet, assets are classified as current, fixed, financial, and intangible assets. A company usually purchases or creates an asset to increase its business value or benefit the business’s operations.

A company’s asset can be thought of as anything that can generate cash flow, reduce expenses, or improve sales, in the future, regardless of whether it’s manufacturing equipment or a patent. Just like in the case of prepaid rent; paying rent in advance would reduce the rent expense that would be incurred in the future which is of economic value to the company. Because an asset contains an economic value, it can increase the value of a business, benefit a company’s operations, or raise an individual’s net worth.

Assets are used for the daily operation of a business and can be currently available to sell or available for long-term sale. A company having a high proportion of assets compared to its liabilities is an indicator of a successful business. The reason is that a high proportion of assets to liabilities indicates a sign of a higher degree of liquidity.

Assets are something that may be scarce. They have the ability to generate cash inflows or decrease cash outflows in order to produce economic benefit. An asset would provide a current, future, or potential economic benefit for an individual or company, if not it cannot be considered as one. Hence, in order for an item to be considered an asset, as of the date of the company’s financial statements, the company must possess a right to this item.

Assets could be categorized into tangible or intangible assets based on physicality. The company’s physical and real properties are known as tangible assets such as cash, machinery, equipment, bonds, real estate, furniture, inventory, etc. These kinds of assets are easily convertible to cash and as such are considered current assets. Intangible assets, on the other hand, are the items or property of the company that do not exist physically but exists theoretically such as patents, permits, intellectual property, brand reputation, logos, business licenses, and trademarks. These assets have their value boosted through successful use and cannot be converted to cash easily.

On the balance sheet, the company’s assets, are grouped into current and fixed assets. This categorization is based on their liquidity. Current assets are highly liquid and can be sold and converted easily into cash. That is, a company’s current assets are the short-term economic resources that are expected to be converted into cash or consumed within one year such as inventory, cash and cash equivalent, accounts receivable, and prepaid expenses.

Prepaid expenses as a current asset are incurred when companies make prepayments for goods or services such as leased office space, equipment, or insurance coverage that provide continual benefits over time. Therefore, a prepaid expense is an asset on the balance sheet which results from a business making payments in advance for goods or services to be received in the future.

These kinds of goods or services that are paid for in advance cannot be expensed immediately because the expense would not line up with the benefit incurred over time from using the asset. Prepaid rent, which is our main focus is a type of prepaid expense and as such is an example of a current asset. The prepaid rent is recorded initially as an asset, but its value is expensed over time onto the income statement. Compared to conventional expenses, a business, over the course of several accounting periods will receive something of value from the prepaid rent.

Furthermore, inventory, cash & cash equivalent, accounts receivable, and prepaid expenses are not the only current assets; financial assets such as stocks, mutual funds, bonds, and other marketable securities are also current assets. Fixed assets, on the other hand, also known as noncurrent assets, hard assets or long-term assets are not as liquid as current assets. They are generally considered to have low liquidity because these assets may take a long period of time to earn cash value. They usually cannot be converted into cash within one year or be sold at their desired value quickly. Such kinds of assets include land, buildings, furniture, or any other type of asset that is not intended for sale within the year.

Furthermore, assets can be grouped into operating and non-operating assets. This categorization is dependent on whether they are used for the operational activities of the company. Operating assets are assets that are needed to generate revenue or income through day-to-day business operations and therefore help to maintain workflows. Since prepaid rent is one of the assets acquired for use in the conduct of the ongoing operations of a business; it can be considered to be an operating asset. Other examples of operating assets would include other prepaid expenses, cash, machinery, accounts receivable, inventory, licenses, copyrights, and some fixed assets.

Non-operating assets, on the other hand, are assets that the company uses to generate revenue even though they are not necessarily needed for the day-to-day running of the business. That is, those assets used for long-term investment purposes, such as marketable securities, assets held for sale, and non-cash asset that is held for investment purposes, such as investment property, vacant land or short-term investments are non-operating assets.

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The amount of prepaid rent is reported on the balance sheet of a business renting a property as a current asset account that will be expensed at some point in the future. As a business does its bookkeeping, a prepaid rent expense account will allow the bookkeeper to track the value of the prepaid rent as an asset until the time that the advance payment amount in the account is used up.

Should prepaid rent be recognized as an asset? When looking at the definition of an asset, recall that an asset is considered to be something that provides a current, future, or potential economic benefit for an individual or company. It is something that is owned by the company or something that is owed to the company. Paying rent in advance is a typical example of an asset. This is because prepaid rent provides a future economic benefit to the company by reducing rent expenses when incurred.

Therefore, when a company prepays for an expense, it is recognized as a prepaid asset on the balance sheet. The entry of this prepaid expense amount is done with a simultaneous entry being recorded that reduces the company’s cash or payment account by the same amount. The majority of prepaid expenses appear on the company’s balance sheet as a current asset except the expense is not to be incurred until after 12 months, which is actually rare.

Prepaid rent is, therefore, recorded on the balance sheet as a prepaid expense in the asset section together with other current assets as seen in the Tesla balance sheet sample below:

A business will record prepaid rent as an asset on the balance sheet because it represents a future benefit due to the business. As the benefits of the advanced rent payment are realized over time, the prepaid rent value is decreased, and the amount is expensed to the income statement. Therefore, prepaid rent is first recorded on the balance sheet, in the prepaid expense/asset account because it represents a future benefit that is due to the business. It is recognized as a current asset because it is expected to be consumed, used up, or expired through standard business operations within one year.

Therefore, as the benefits of the prepaid rent are realized, it is recorded on the income statement. This prepaid rent is not initially recorded on the income statement because according to the Generally Accepted Accounting Principles (GAAP) matching principle, expenses cannot be recorded on the income statement before they incur.

Conclusively, prepaid rent is said to be a permanent account since it is reported as a current asset on the balance sheet. Permanent accounts are accounts on the balance sheet, which include transactions related to assets, liabilities, and equity. Nevertheless, once the prepaid rent has been used up, exhausted, or expired, the expense is recorded on the income statement.

Related: Is Dividends an Asset?

Prepaid rent as a current asset

Businesses, in order to get a discount, may prepay their rent to cover months in advance. Apart from the discount, businesses may have no choice but to make a prepayment because the landlord requested it. Whichever way, prepaid rent is treated as a prepaid expense which is recorded as a current asset on the balance sheet until it has been used up.

When a company prepays for an expense, it is recognized as a prepaid asset on the balance sheet. The entry of this prepaid expense amount is done with a simultaneous entry being recorded that reduces the company’s cash or payment account by the same amount. Hence, when it comes to accounting for prepaid rent, the proper way to account for it is to record the initial payment in the prepaid rent (or prepaid assets) account, using the entry below:

Then, when the check is cut, the journal entry will be:

Also, the business can sometimes record the following entry during the month to which the rent payment actually applies, which finally charges the payment to expense:

The bottom line is that a prepaid rent payment should be recorded on the balance sheet as an asset until the very month that the company is actually using the property to which the rent relates. When this prepayment for the property has been used up, it is then charged to the expense account.

One thing that is very important to note when recording prepaid rent is to not forget to shift the prepaid rent into an expense account in the exact month that the rent is consumed. If this is not done, the financial statements would over-report the asset and under-report the expense. Hence, in order to prevent this, it is advisable for the bookkeeper to keep track of the contents of the prepaid rent (or prepaid assets) account. It is best that the prepaid rent account is reviewed before closing the books at the end of each month.

Let’s look at an example of how prepaid rent is reported in the accounting records

An example

Assume Company ABC pays rent to the landlord of office space on the 31st of December, 2020 for the next 1 year till the 31st of December 2021. The Company follows the financial year of accounting and in that year the rent paid is $100,000 per month. In such an instance, the entire money that is paid to the landlord as rent will NOT be considered to be expenses for the fiscal year 2020-2021 (FY 20-21). Rather, only rent for three months will be reported as expenses for the month of Jan 20 – Mar 20. The remaining nine months of rent will then be reported as Prepaid Expenses under the heading Other Current Assets on the Asset Side of the Balance Sheet.

The entry for this is as follows:

Therefore, for FY 20-21, the journal entry will be:

Therefore, for FY 21-22, the journal entry will be:

See also: Is accumulated depreciation an asset?

Conclusion

In conclusion, prepaid rent is a current asset. It is a payment on a lease of property that is made in advance. Therefore, it is reported in the current asset account on the balance sheet representing the amount of future rent expense that has been paid in advance of the rental period.

Prepaid rent represents the amount that has not yet been used up or expired as of the balance sheet date. Therefore, it must be recorded as an asset on the balance sheet until the very month that this advance payment is exhausted. Then, when it eventually gets to the exact month that the rent is consumed, the asset-prepaid rent is shifted into an expense account. This means that the prepaid rent is recorded initially as an asset, but its value is expensed over time onto the income statement.

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