Is prepaid rent debit or credit? In order to operate their business, companies usually need a building to use as their office, warehouse, or manufacturing plant. If this building is not owned by the company, it means they will have to make payments to the owner of the building for using the building. The payments made to the landlord are called rent. Generally, companies who lease buildings for their operations make a prepayment to the owner of the building. This prepayment is referred to as prepaid rent.
When a prepayment is made for rent, the company records it as an asset on its statement of financial position along with other prepaid expenses in the current assets section. This prepayment gets recorded as an expense on the company’s income statement once the period for which the prepayment was made elapses. Since businesses usually make journal entries for all transactions carried out, it is necessary to understand whether prepaid rent is a debit or a credit so that errors will be avoided when recording it. Before we discuss prepaid rent as debit or credit, let us have a look at what it means.
See also: Is Investment Debit or Credit?
What is prepaid rent?
Prepaid rent refers to the amount paid in advance by a company to the landlord for leasing his property. Thus, it is a payment made before the actual rental period to which it is related. Depending on the rental agreement, this prepayment can be made to cover a month, quarter, or year. Monthly prepayments are however the most common.
Prepaid rent is a property lease payment made for a future time. Although the company makes the payment for rent, it will be recorded as prepaid rent since the expense has not yet been incurred. This prepaid amount is reduced as it gets used up and the expense gets incurred. If for instance, a company makes prepaid rent payments for a year, the amount will be expensed monthly as the rent gets used up by the company.
The main indicator for prepaid rent is the timing. Thus, when businesses make lease payments earlier than they are used, they get recorded as prepaid rent. When the rental period that was prepaid for reaches, the company will reduce the prepaid rent account and record the expense. Simply put, prepaid expenses are expenditure payments for rent that are paid in one accounting period and expensed in a different period. Since the prepaid rent has future economic benefits to the company before they get expensed, they are first considered assets. When the benefits are realized by the company, prepaid rent is then recognized as an expense.
Accounting for prepaid rent
Companies have two options when it comes to keeping a record of the transactions they make. They can either use the accrual accounting method which recognizes the expense once it has been used irrespective of payments being made or not or the cash accounting method which only recognizes expense when it has been paid for. Most companies however use the accrual accounting method.
For prepaid rent, if the accrual accounting method is used, it will be first recorded as prepaid rent and then moved to the rent expense account once it gets to the period for which the prepayment was made. If the cash accounting method is used, the amount is recorded within the accounting period for which the rent is used up. Now that we have understood what prepaid rent means and how it can be accounted for, let us see whether prepaid rent is a debit or credit.
See also: Utilities payable debit or credit?
Is prepaid rent a debit or credit?
Similar to other prepaid expenses such as prepaid insurance, prepaid rent is a debit and not a credit; this is because it is a future expense whose payment has been made in advance.
Depending on how long the rental payment covers, corresponding charges to rent expenses will be made as the rent is consumed. If the prepaid rent covers a period of one year, then a series of related charges are made to the rent expense account. This is done to account for any rent that is consumed.
When the prepaid rent payment is first made, it is recorded as a debit to the prepaid rent account to indicate that there has been an increase in the current asset of the company. Later on, when the rent is used up, it is recorded as a credit to the prepaid rent account to indicate that there has been a decrease in the account. Let us look at the journal entries for prepaid rent using debits and credits to understand further why prepaid rent is a debit and not a credit.
Journal entries for prepaid rent as debit or credit
When companies pay rent in advance, they record the transaction by making a journal entry. This journal entry is made to track transactions and to ensure that when making financial reports, all transactions are well captured and accurately reported. It also aids in ensuring that the Generally Accepted Accounting Principles (GAAP) are followed when preparing reports that will be filed with the U.S. Securities and Exchange Commission (SEC).
When transactions are to be recorded, the accounting debit and credit rules have to be applied. When debits and credits are made to accounts, it is pertinent that the amount recorded as a debit is equal to the amount recorded as a credit. Hence when a company decides to make a prepayment for rent and pays for the prepaid rent, it is recorded as a debit to the prepaid rent account and a debit to the cash account as shown in the table below:
When the prepaid rent is used up, another journal entry is made to show this transaction. It involves a debit to the rent expense account and a credit to the prepaid rent account. This journal entry is an adjusting journal entry and will be as shown in the table below:
Examples of prepaid rent as debit and credit
We will look at some hypothetical examples on prepaid rent payment and how they are recorded when the payment is made and once the rent has been used up.
Example one: Monthly prepaid rent payment
Suppose the monthly rental payment for a car manufacturing company is $10,000. If they make a prepayment on November 22, 2022, for the December rent, the journal entry to record the transaction will be as follows:
Journal entry for prepaid rent payment for a car manufacturing company
Once the month of December elapses and the rent has been used up by the car manufacturer, a new journal entry will be made to show the transaction as follows:
Journal entry for used-up prepaid rent by a car manufacturer
Example two: Yearly prepaid rent payment
Assuming a brewery pays rent on its production plant. If the monthly rent costs $18,600 and the lease agreement stipulates that rental payments have to be made annually, and must be prepaid in December of the preceding year. Suppose the brewery makes the prepayment for 2023 on December 20, 2022. The brewery will record this prepaid rent transaction as shown in the table below:
Journal entry for yearly rent prepayment
The monthly payment of $18,600 is multiplied by the number of months (12) to arrive at the total amount of $223,200 which is paid by the brewery.
Since the payment covers a whole year, the brewery will make monthly adjusting entries at the end of every month to account for the monthly rent that has been used. The adjusting entry for the month of January will be as follows:
Journal entry to record January rent expense
Each month, an entry similar to the one above will be made by the brewery to account for the rent which has been expensed at the end of that month.
See also: Is Notes Payable a Debit or a Credit?
Prepaid rent is a debit and not a credit
Is prepaid rent a debit or a credit? Prepaid rent is an asset account, when making a journal entry for it, it will be recorded as a debit to the prepaid rent account. This means that prepaid rent is a debit and not a credit. However, when the prepaid rent has been used up, the prepaid rent account gets credited while the rent expense account gets debited. This is done to indicate a decrease in the company’s current asset (prepaid rent) and the consequent increase in its expense account (rent expense)
Video: Prepaid rent debit or credit?
Explaining prepaid rent as a debit and not a credit
- Capitalism vs Liberalism Differences and Similarities - January 23, 2023
- Features of Socialism - January 19, 2023
- LME vs CME: Coordinated Market Economy vs Liberal Market Economy - January 18, 2023