Is prepaid rent a permanent account? Prepaid rent is the rent paid before the rental period to which it is related. Recording rent paid in advance could be a bit of a hassle because the payment would normally appear as rent expense in the income statement during the time at which the invoice was entered into the accounting software.
Nevertheless, this payment is actually a prepaid rent because the payment was recorded and the check was cut in the month that is before the period to which the payment relates. At times, payments are made in advance for future benefits. These advance payments also known as prepaid expenses are recorded in accounting as assets on the balance sheet. Hence, prepaid rent is recorded on the balance sheet as the amount of rent paid that has not yet been used.
Since it is recorded on the balance sheet, is prepaid rent a permanent account or a temporary account? In this article, we will discuss whether prepaid rent is a permanent account or a temporary account.
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What is prepaid rent?
Prepaid rent is an advance payment on a lease of property; a current asset account that reports the amount of future rent expense that has been paid in advance of the rental period. The amount reported on the balance sheet as the prepaid rent is the amount that has not yet been used up or expired as of the balance sheet date.
The amount of the prepaid rent is carried on the books of a business renting the property as a current asset account that will be expensed at some point in the future. As the business does its bookkeeping, the prepaid rent expense account allows the bookkeeper to track the value of the prepaid rent as an asset until the time that the amount in the account is spent.
All businesses must maintain bookkeeping records in order to meet tax and other regulatory obligations. Periodically, businesses generate a set of financial statements to summarize their financial position which conforms to a set of generally accepted accounting principles that standardize financial reporting, for comparison to other businesses.
When a business enters into a rental agreement to lease property, it usually has to pay not only the current month’s rent but also a certain number of months in advance as security for performance under the agreement. Upon the satisfaction of certain conditions, this security deposit can be refundable at the end of the lease or can be treated as a nonrefundable prepayment that pays the months at the tail end of the agreement. However, whether the security deposit is refundable or non-refundable would determine how the amount is treated for bookkeeping purposes.
The non-refundable rent payments that cover the rent for future months are carried on the books of the property’s owner as deferred unearned revenue. Whereas, on the books of the business renting the property, the amount is carried in the prepaid rent expense account. This account is capitalized or decreased when an amount of the prepaid rent is actually used up to pay for a month’s rent.
The prepayment of rent can apply to months that are years in the future. Therefore, until the amount of prepaid rent is actually applied 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 company to show that it has a current asset that will benefit the company at a future date.
Prepaid rent as a prepaid expense in accounting
Businesses may prepay rent that covers months in advance in order to get a discount, or probably because the landlord needed a prepayment. Whichever way, prepaid rent is treated as prepaid expenses in accounting which is recorded as an asset on the balance sheet until it has been used up.
When a company prepays for rent (expense), it is recognized as a prepaid asset on the balance sheet, with a simultaneous entry being recorded that reduces the company’s cash (or payment) account by the same amount. Therefore, in accounting, the proper way to account for prepaid rent is to record the initial payment in the prepaid rent (or prepaid assets) account, using the entry below:
Then, the accounting software records the following entry, when the check is cut :
Lastly, the business records the following entry sometime during the month to which the rent payment actually applies, which finally charges the payment to expense:
In fact, a prepaid rent payment should be recorded on the balance sheet as an asset until the month when the company is actually using the facility to which the rent relates. When the prepayment has been used up, it is then charged to the expense account.
A major concern when recording prepaid rent is that one might forget to shift the asset into an expense account in the exact month that the rent is consumed. If this occurs, the financial statements would under-report the expense and over-report the asset. Therefore, in order to avoid this, it is best for the business to keep track of the contents of the prepaid rent (or prepaid assets) account. The account should be reviewed before closing the books at the end of each month.
Nevertheless, the accounting treatment for prepaid expenses is different under the cash basis accounting. In this accounting method, expenses 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, irrespective of the period to which the rent payment relates.
An example of prepaid rent in accounting
Assume Company ABC is paying for an office space for six months in advance, for a total of $24,000. The initial journal entry for this is as follows:
Then, the prepaid rent balance sheet account is reduced as each month ends by the monthly rent amount, which is $4,000 per month (i.e $24,000/6 months).
At the same time, the company would recognize a rental expense of $4,000 on the income statement. As a result, the monthly adjusting entry would be as follows:
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Permanent and temporary accounts explained
Permanent accounts are the accounts that continue to maintain ongoing balances over time. They are accounts that are not closed at the end of the accounting period and are aggregated into the balance sheets. Permanent accounts are measured cumulatively and refer to the asset, liability, and equity accounts that are reported in the balance sheet. That is, the accounts that are reported on the balance sheet such as asset accounts, liability accounts, and capital (equity) accounts are all permanent accounts.
Asset accounts such as Prepaid rent, Prepaid Expenses, Accounts Receivable, Cash, Inventories, Furniture and Fixtures, etc. are all permanent accounts. Even contra-asset accounts such as Accumulated Depreciation and Allowance for Bad Debts are also permanent accounts. Liability accounts such as Notes Payable, Interest Payable, Accounts Payable, Loans Payable, Rent Payable, and Utilities Payable are all examples of permanent accounts.
The capital accounts of all types of businesses are permanent accounts such as capital stock, reserve accounts, and retained earnings in corporations as well as owner’s capital accounts in a sole proprietorship, and partners’ capital accounts in partnerships.
Temporary accounts, on the other hand, are accounts that begin each fiscal year with a zero balance. At the end of the year, the ending balance of a temporary account is shifted to a different account, which is to be used again in the next fiscal year to accumulate a new set of transactions. At the end of the fiscal year, the ending balances in temporary accounts are shifted to the retained earnings account.
The process of shifting the balances out of a temporary account is known as closing an account. The balances in temporary accounts usually increase over the course of a fiscal year; they rarely decrease. These types of accounts are used to compile transactions that impact the profit or loss of a business during a year. Hence, the balances in temporary accounts are used to create the income statement.
Therefore, the types of temporary accounts include revenue accounts, expense accounts, gain and loss, and the income summary account. Hence, examples of such accounts are revenue/sales, cost of goods sold, compensation expense, supplies expense accounts, loss on assets sold account etc. This means that temporary accounts include transactions related to revenue and expense that are aggregated into the income statement.
In conclusion, all the income statement accounts are temporary accounts and all the balance sheet
accounts are permanent accounts.
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Is prepaid rent a permanent account?
Yes, prepaid rent is a permanent account. Permanent accounts are accounts that are aggregated into the balance sheet, which include transactions related to assets, liabilities, and equity. Since prepaid rent is recorded as an asset on the balance sheet, it is a permanent account. However, once the prepaid rent has been used up or expired, the expense is recorded on the income statement.
The majority of prepaid rent (or expenses) appear on the balance sheet as a current asset unless the expense is not to be incurred until after 12 months, which is actually rare. Prepaid rent is a type of prepaid expense. Prepaid expenses are classified as assets because they represent goods or services that will be received in the future, usually within a year.
At times, payments are made in advance for future benefits. These prepaid expenses are recorded in accounting as assets on the balance sheet. But once incurred, the expense is recorded on the income statement and the asset account is reduced. Nonetheless, the GAAP matching principle prevents these expenses to be recorded on the income statement before the asset is actually realized.
Conclusively, prepaid rent is not recorded on an income statement initially; rather it is first recorded on the balance sheet as a permanent account. Then, as the benefit of this prepaid expense is realized, or as the expense is incurred, it is recognized on the income statement.
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Why prepaid rent is a permanent account and not a temporary account
Prepaid rent (or prepaid expenses) aren’t included in the income statement in accordance with the Generally Accepted Accounting Principles (GAAP), and as such are not temporary accounts. The GAAP matching principle in particular requires accrual accounting, which demands that revenue and expenses must be reported in the same period as incurred no matter when cash or money exchanges hands. This means that expenses should be recorded when incurred. Therefore, prepaid rent as a prepaid expense isn’t recognized on the income statement when paid because it is yet to be incurred. It is therefore recorded on the balance sheet as an asset making it a permanent account.
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