Although recent advancements in technology have led to a lot of businesses adopting remote work options, most businesses still have a physical location that is used as an office. Due to the high cost of real estate, most of these companies do not own their offices, rather they pay a certain amount to the owners of the building. The amount of money that these companies pay to the owners of the buildings they occupy is classified as rent expense.
Rent expense is recorded on the income statement in the operating section. It is recorded between the production and the selling and administrative part of the income statement or charged solely to the selling and administrative part. In order to attract the target customers, companies often pay a large sum towards getting located in places that are accessible. These companies often weigh the cost of rent vis-a-vis the revenue that could be accrued from being located in such prime locations.
The location of a company is important specifically for companies that are into production and sales of goods. Rent expense is an account that outlines the rental cost incurred by companies within a specified accounting period and is one of the large expenses accrued by companies after the cost of goods sold and salaries expense.
But as stated earlier, the onset of remote work is gradually reducing the amount companies spend as rent expense since a majority of employees and companies are adopting the remote work option. This has led a lot of companies to require smaller office spaces and thus, reducing the amount spent on rent expenses. But, how is rent expense recorded? Is rent expense debit or credit? We shall discuss rent expense as debit or credit after we have understood what rent expense means.
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What is rent expense?
Rent expense is the amount that businesses pay for occupying the buildings which they use for various business operations or productions such as offices, warehouses, production plants, etc. Rent is a typical expense for almost all companies unless they own the building in which they operate. Rent expense offsets the income of a company and is generally not tax deductible.
Depending on the rent payment arrangement, it could be paid monthly, quarterly, or yearly. Rent expense is reported within the accounting period in which the rent was paid. Rent expenses can be classified as production costs or administrative costs. This classification depends on the aspect of the business operation the building caters to; if the building is used for the production of the goods that the company sells, then, the rent expense will be considered production cost. If the building is used for other daily business operations, the rent expense will be classified as an administrative expense.
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Generally, however, since most companies use the same building for production and daily business operations, the rent expense for such companies is split into the cost per square foot. This is done in order to properly account for the rent expense with the part of the building that caters to the production of goods accounting for the production cost and the other part of the building accounting for the administrative expense. In either case, both the production cost and the administrative expense are both rent expenses and they offset the company’s profits.
Rent expense is usually reported as an actual expense for the month, quarter, or year in which it is paid and should therefore not be confused with prepaid rent which is part of a company’s assets. Since rent is generally a large sum, recording the transaction for its payment accurately is very important. Hence we shall discuss the two basic ways of accounting for rent expenses.
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Accounting for rent expense
- Accrual basis accounting
- Cash basis accounting
Accrual basis accounting
Using the accrual basis of accounting, any revenue is listed on the income statement once it is earned; this is irrespective of whether the cash has been received or not. For rent expense, it is recognized as an expense in the period within which the business occupies the building; irrespective of whether the actual cash was paid for the space. Rent expense under the accrual accounting basis is mainly based on the amount of usage within the accounting period.
With the accrual basis accounting, the rent expense is majorly prepaid and is often recorded as a prepaid expense but once the company starts using the space or time passes and the expense becomes current, the rent payment is moved to the rent expense account.
Cash basis accounting
Using the cash basis of accounting, rent expense is the amount of cash that the company spends on rent within the stipulated accounting period. Hence any amount paid either monthly, quarterly, or yearly for rent is reported as rent expense.
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Is rent expense debit or credit?
Depending on the contractual agreement between the lessor (building owner or landlord) and the lessee or tenant (the company), rental payments may be made monthly, quarterly or yearly. When the rental payment is made, it is usually recorded as a debit to the rent expense account and a credit to the account from which the payment was made. Therefore, rent expense is a debit and not a credit.
Rent expense is an expense on the company’s income statement and calculated as an actual expense in the month, quarter or year that it was paid. It is recorded as a debit balance on the balance sheet. When rent expense is paid, it might include additional charges such as insurance, security, facilities management, maintenance, utilities, etc. All these extra payments are charged to the rent expense account since they contribute to the overall amount that will be paid as rent since they all lead to a reduction in the company’s funds.
Journal entries for rent expense
Rent expense usually shows up on the balance sheet as a debit and is a vital part of a company’s transactions. Due to the large amount that is generally spent on rent expenses, the journal entries for it needs to be correctly done to have a well-recorded financial statement. This is in order to have a correct record of the company’s expenses. Rent expenses generally reduce the company’s equity or assets since the rental payment is deducted from either of the accounts. As such, the rent expense account is credited while the account from where the payment is made is credited.
When making journal entries, the double-entry accounting method is the most commonly used. With this method, any debit must be accounted for with equal but opposite credit. This is done in order for the company’s books of account to be balanced and to ensure that the company’s assets are equal to the sum of its liabilities and equities. Additionally, all funds have a source from where they were generated and also have a source for which they are spent. Hence double-entry accounting also keeps track of these transactions showing what accounts are involved in a transaction.
For the rent expense, the accounts involved are the rent expense account and the cash account. This is because most time, rental payments are made in cash. Here, cash is used to account for payments via bank transfers, cheques, or card payments. The rent expense will require a debit to the rent expense account and a credit to the cash account.
Example of rent expense as a debit and not a credit
For instance, if the monthly rent expense of Alphabet is $300,000 and they pay via bank transfer to their landlord; it signifies a reduction in their bank balance (cash) of $300,000. This will be recorded as a debit of $300,000 to the rent expense account in the month for which the rental payment was made and a credit to the cash account.
The journal entry for the transaction will be recorded as follows:
Debit and credit journal entry for rent expense paid in cash
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Conclusion on rent expense as debit and not a credit
Since the payment of rent is an expense, it means that the rent expense is a debit balance and not a credit balance. Rent expense is a debit just like other company expenses because it results in a reduction in the company’s current asset of cash. The payment made can be monthly, quarterly, or yearly depending on the contractual agreement between the company (tenant) and the landlord.
The use of the building also affects whether the rent expense will be classified as operating cost or production cost. Manufacturing companies generally record rent expense as production cost since the payment usually covers for the space used in the production of goods. Service providers such as car repair shops record their rent expense as operating cost since it covers for the space where they provide services to their customers. Companies that offer both products and services split the rent expense between the production cost and operating cost to cover the various activities.Last Updated on November 4, 2023 by Nansel Nanzip Bongdap
Blessing's experience lies in business, finance, literature, and marketing. She enjoys writing or editing in these fields, reflecting her experiences and expertise in all the content that she writes.