Prepaid Rent Journal Entry
Overview
Prepaid rent is the amount the company pays in advance to use the rental facility (e.g. office or equipemnt, etc.). Hence, the company needs to properly make the prepaid rent journal entry to avoid the error that leads to misstatement due to prepaid rent is not appropriately recognized in accounting.
In accounting, prepaid rent is not an expense but an asset. Likewise, as an advance payment, prepaid rent doesn’t affect the total assets on the balance sheet. What it does simply trades one asset (cash) for another asset (prepaid rent).
However, similar to prepaid insurance, the prepaid rent will expire through the passage of time. So, the company needs to recognize the expiration cost as a rent expense at the end of the period.
Prepaid rent journal entry
The company can make the prepaid rent journal entry by debiting the prepaid rent account and crediting the cash account after making the advance payment for the rent of facility.
| Account | Debit | Credit |
|---|---|---|
| Prepaid rent | 000 | |
| Cash | 000 |
Likewise, the journal entry here doesn’t involve an income statement account as both prepaid rent and cash are balance sheet items. Hence, the journal entry above is simply increasing one asset (prepaid rent) together with the decreasing of another asset (cash).
At the end of the month, the company can make journal entry by debiting the rent expense account and crediting the prepaid rent account to recognize the expense and reduce the balance of prepaid rent after using the rental facility in the period.
| Account | Debit | Credit |
|---|---|---|
| Rent expense | 000 | |
| Prepaid rent | 000 |
Likewise, if the company doesn’t account for rent expense by reducing prepaid rent as in the above journal entry, the company’s total assets will be overstated while the total expenses will be understated.
Prepaid rent example
For example, on December 28, 2020, the company ABC makes an advance payment of $5,000 to use a rental facility for two months in January and February 2021 for its business operation.
In this case, the company ABC needs to make the prepaid rent journal entry on December 28, 2020, by recording the advance payment of $5,000 as prepaid rent as below:
| Account | Debit | Credit |
|---|---|---|
| Prepaid rent | 5,000 | |
| Cash | 5,000 |
Likewise, there are no changes in total assets because while an asset account which is prepaid rent increases by $5,000, another asset account which is a cash account decreases by $5,000.
And on January 31, 2021, the company ABC can make the journal entry to recognize rent expense for one month in the adjusting entry below:
| Account | Debit | Credit |
|---|---|---|
| Rent expense | 2,500 | |
| Prepaid rent | 2,500 |
The company ABC makes this journal entry to also reduce the balance of prepaid rent by $2,500 ($5,000 / 2) because the benefit of the expenditure has already been used up by one month in January.
Likewise, without the adjusting entry above, assets are overstated and expenses are understated by the same amount of $2,500 as at January 31, 201. That is why the company needs to make the January 31 adjusting entry above by increasing $2,500 in an expense account (rent expense) and decreasing $2,500 in an asset account (prepaid rent).
And later, on February 31, 2021, the company ABC can make another journal entry to reduce prepaid paid by another $2,500 as below:
| Account | Debit | Credit |
|---|---|---|
| Rent expense | 2,500 | |
| Prepaid rent | 2,500 |
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).