What type of account is rent expense? Rent expense is the cost that a business incurs to use a property or location for an office, factory, retail space, or storage space. For a business, it is a type of fixed operating cost or an absorption cost, as opposed to a variable expense. This expense is usually subject to a one or two-year contract between the lessor and lessee, with options to renew. In this article, we will discuss what type of account rent expense is and how it is accounted for.
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What is rent expense in accounting?
Rent expense is the cost of occupying a rental property during a reporting period. This is the sum of money a corporate tenant or individual pays a landlord on a periodic basis, either every month or quarterly. Depending on the contractual agreement, the landlord may require that a tenant (lessee) pay extra cash to cover things like facilities management, maintenance, security, and insurance.
Rent expense is usually recorded on the income statement and allocated between the selling and administrative, or production portions of the statement. After the cost of goods sold and compensation expenses, rental expenses are one of the larger expenses reported by most organizations. However, this expense in most organizations may trend downward over time as a greater proportion of their employees work from home.
In bookkeeping, when a corporate lessee pays rent, the office rent expense account is debited and the cash account is credited. Accounting for rent expense differs under the cash basis and accrual basis of accounting. The amount of cash paid during an accounting period is the amount of rent expense reported in that period under the cash basis of accounting.
However, under the accrual basis of accounting, the amount of usage of the rental property during a period is the amount of rent expense reported for that period irrespective of the amount of money actually paid during that period. Also, under the accrual basis of accounting, an advance payment of rent is initially recorded as an asset in the prepaid rent or prepaid expense account and is later recognized as an expense in the period in which the business occupies and uses the space.
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What type of account is rent expense?
Rent expense is a type of expense account reported on the income statement. It is considered an expense because it is an operational cost that a business or company incurs in order to generate revenue. According to the guidelines in accounting, rent expense belongs to the ‘selling, general, and administrative accounts‘ (SG&A) category. Other SG&A items include expenses as diverse as office supplies, litigation, money a business pays to settle regulatory liabilities, depreciation, salaries, and insurance.
The rent expense is one of the expenditures that allow a company to operate. Therefore, as an SG&A cost, rent expense is considered an operating expense account. This is because a business uses real property such as production plants and office buildings to operate, make money, and exist commercially.
Rental payment is calculated as an actual expense for the month in which it is being paid. Since it is such a large percentage of a business’s expenses, it is important for it to be calculated and recorded correctly on all of the business’s financial statements to make sure that the most accurate picture of the business’ expenses and profit margin is being shown.
Expense and revenue accounts are usually reported in a company’s profit and loss statement and the company’s net profit is gotten by subtracting expenses from the total revenue generated, giving an insight into the profitability of the company. In a profit and loss statement prepared under the multi-step approach, SG&A items come underneath line items such as revenue, merchandise expense, and gross profit (total revenues minus inventory costs). Hence, the gross profit minus SG&A expenses (like rent expenses) equals the company’s operating income.
Furthermore, under the accrual basis of accounting, the Rent Expense Account will report the cost of occupying space during the time period indicated in the heading of the income statement, irrespective of whether or not the rent was paid within that period.
What is rent expense classified as?
A rent expense can either be classified as a production expense or an administrative expense depending on the use of the space for which the rent is being paid. It is classified as a production cost if the space is being used specifically to manufacture and produce the product that the business sells. This is because the rental expense would be calculated into the cost of production. On the other hand, rent expense can be classified as an administrative cost if it is part of the expenses that are necessary to perform the day-to-day operational activities of the business.
Therefore, depending on the use of the space, Rent Expenses could be reported on the income statement as part of selling expenses or administrative expenses. However, if the rented space was used to manufacture goods, it would be reported as part of the cost of the products produced.
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Rent expense as an expense account
Rent expense is a type of expense account. Like any other expense, a company must account for its rental expense on the income statement. A basic multiple-step P&L statement separates operating expenses from non-operating expenses. The rental expenses can be a material portion of operating expenses or a negligible one depending on the type of business.
For retail businesses that do not own their own property, rent expense is one of the main operating expenses together with employee wages, marketing, and advertising costs. Manufacturing companies, on the other hand, usually spend low amounts in rent expenses as a percentage of total expenses. The rent expenses for manufacturing operations are therefore included in factory overhead, while the rent expense that is not tied to production (e.g administrative office space rent) is charged to operating expenses.
Journal entry example to show rent expense as an expense account
So, what type of account is rent expense? Rent expense is an expense account. Therefore, when accounting for rental payments, the two accounts that will be involved are the rent expense account and the cash account. According to the accounting debit and credit rules, accounts such as expenses, assets, and dividends have a natural debit balance that will increase in amount when a debit entry is added to them and decrease when a credit entry is added to them.
Therefore, because rent expense is considered an expense account, it will be debited to record the rental usage while the cash account will be credited. Just like other expense accounts, rent expense results in a reduction in the company’s current asset of cash.
Let us look at an example of how to record rent expenses in accounting:
Take, for instance, $500,000, is the monthly rent expense of ABC Company and the company makes a bank transfer to the landlord. This causes a reduction in the company’s bank balance (cash) by $500,000. The journal entry for this rent expense example will be recorded as follows:
| Date | Account | Debit | Credit |
|---|---|---|---|
| 28/02/2023 | Rent expense | $500,000 | |
| Cash | $500,000 |
When accounting for the rental payment, the entry will be recorded as a debit of $500,000 to the rent expense account and a credit of $500,000 to the cash account, in the month that the rent was paid. As seen from the journal entry, being an expense account, rent expense is a debit entry.
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Last Updated on November 3, 2023 by Nansel Nanzip Bongdap
Obotu has 2+years of professional experience in the business and finance sector. Her expertise lies in marketing, economics, finance, biology, and literature. She enjoys writing in these fields to educate and share her wealth of knowledge and experience.
