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Rent Accounting under ASC 842: Prepaid, Base, Accrued, Contingent, and Deferred

Lease payments decrease the lease liability and accrued interest of the lease liability. A lease expense, equivalent to the straight-line rent expense recognized under ASC 840 for operating leases, is recognized for interest accrued on the lease liability and amortization of the ROU asset. We can record the accrued rent expense with the journal entry of debiting the rent expense account and crediting the rent payable account at the period-end adjusting entry. Under ASC 842 base rent is included in the establishment of the lease liability and ROU asset. The amortization of the lease liability and the depreciation of the ROU asset are combined to make up the straight-line lease expense.

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In conclusion, accounting for rent expense is changing insignificantly from ASC 840 to ASC 842. Now if only the same thing could be said about the accounting for operating leases. Deferred rent is primarily linked to accounting for operating leases under ASC 840. Nevertheless, differences between lease expense and lease payments accrued rent journal entry also exist under ASC 842. This comparison of deferred rent treatment under ASC 840 and ASC 842 is illustrated in Deferred Rent Accounting and Tax Impact under ASC 842 and 840 Explained. This latter situation tends not to last long, since the renter will have violated the terms of the rental agreement, and can then be evicted.

What Are Balance Day Adjustments?

The annual rent expense is $131,397 ($1,313,967 divided by 10 years), and the monthly rent expense is $10,950 ($1,313,967 divided by a lease term of 120 months). As was the case under ASC 840, rent expense is not reported on the balance sheet. It is still only reported on the income statement and calculated on a straight-line basis. Rent is the periodic payment to an entity for the use of their property. At the end of the month, the company will record the situation into their books with the below journal entry. For example, we have an available office space that we can rent out to earn extra income for our business.

Accounting and Journal Entry for Rent Received

I like to use the International Financial Reporting Standards (IFRS) Conceptual Framework and its definitions. IFRS defines economic benefits as cash inflows, control over resources, the extinguishment of debt, etc. By the end of the lease, the balance in the deferred rent account will be zero.

Please read on if you want to know more about why accrual transactions are made and when and work through a few examples. In the case above, the $9,000 principal plus a $900 interest will be collected by the company after 1 year. We can now update the accounting equation and show the second transaction, keeping the equation in balance. And in the accounting equation below, you can see how it remains in balance by increasing both sides of the equation.

On the other hand, accrued rent is a liability account that a tenant uses to report the rent that has not yet been remitted to the landlord as of the date the balance sheet was prepared. Where the rent is meant to be paid on the second day of each month and the tenant meets up with the payment deadline, the rent receivable account will have a zero balance. However, if the tenant defaults in payment, the rent receivable account will be credited while the rent payable account will be debited. From the landlord’s perspective, accrued rent is an asset as it represents revenue that is yet to be paid.

At the same time, we also record this transaction to recognize the rent income on the income statement that we have already earned but have not received the cash payment yet. In business, when we rent our available property or equipment, we may come across a situation where we only receive a rental fee after a certain period has passed. In this case, we need to make the journal entry for accrued rent income at the end of the accounting period, even though we have not received the cash payment yet.

In a situation where the tenant cannot pay and there seem to be no alternative method of payment, the expense should not be reported as accrued expenses. However, as the client has difficulty in their business, we agree to delay the payment until the first week of next month which is July. In this case, the client will need to make a $6,000 cash payment to us in the first week of July, in which the first $3,000 is for the June rental fee and another $3,000 is to cover the July rental fee. Merriam-webster defines the word “accrued” as the process of something being “accumulated over a period of time”. And when it comes to accounting, it means the same thing when dealing with revenue and expenses.

Rent Abatement and Rent-Free Period Accounting under US GAAP

In this example, we calculated a straight-line rent expense of $131,397 per year. We can see from Step 2, the annual payments begin at $120,000 and increase each year to reflect the 2% rent escalation but the expense is consistently recognized on a straight-line basis over the lease term. Under current US GAAP, the FASB states that when rents are not constant, the lease expense should be recognized on a straight-line basis throughout the life of the lease. This method of rent expense recognition is applicable under both ASC 840 and ASC 842 for leases classified as operating leases. Rent expense is an expense account representing the cost incurred by an organization for the right to use or occupy a specified asset that they do not own.

Rent received in advance is shown under current liability in the balance sheet. On December 31st Company  calculated 10,000 as rent earned but not received for 2 months from Jan 20 to Dec 20. Accrued income is listed in the asset section of the balance sheet because it represents a future benefit to the company in the form of a future cash payout. There are some cases when we received rent before the due date of rent under such condition rent received is advance .

How rental income is accrued

However, if a renter does not pay in the rent period, the landlord should accrue the rent in that accounting period, with a debit to an accrued billings (asset) account and a credit to a rent revenue account. When rent is paid in advance of its due date, prepaid rent is recorded at the time of payment as a credit to cash/accounts payable and a debit to prepaid rent. When the future rent period occurs, the prepaid is relieved to rent expense with a credit to prepaid rent and a debit to rent expense. This is due to, under the accrual basis of accounting, the revenue should be recorded when is earned regardless of the time of the cash received. And in accounting, the rental income or rental revenue is earned through the passage of time. Hence, at the end of the accounting period, we should have earned a portion of rent income regardless of when we will receive the cash payment.

Under ASC 840, a rent accrual liability was recorded in periods when rent was incurred, because the company used or occupied the leased asset and not yet made a payment. The entity received the economic benefit of the leased asset in the period and has an obligation to pay for the benefit it received. Since the rent expense is an average, there will be months where cash is more than the straight-line expense and correspondingly months where cash is less than the expense. Deferred rent occurs in periods where the expense incurred is greater than cash paid for rent. The additional rent expense is “delayed” or deferred to be recognized at a later date. Future payments for rent-related to operating leases were previously off-balance sheet transactions.

Hence, the company needs to record the accrued rent revenue that it has earned during the period in order to comply with the accrual basis of accounting. Deferred rent is the result of rent expense being recorded on a straight-line basis when cash paid for rent escalates or de-escalates over the term of the lease. When we make the rent payment for the liability above, we can make the journal entry by debiting the rent payable account and crediting the cash account.

At transition, the cumulative balance in each of those accounts will be removed from the books and the ROU asset will be correspondingly adjusted. Since prepaid rent has a natural debit balance, it will need to be eliminated from the balance sheet with a credit and offset by a debit to the ROU asset, increasing the net asset balance. Deferred rent and accrued rent, being liabilities, will need to be debited in order to be derecognized, and the ROU asset will be respectively credited, decreasing the net asset balance. After the transition, the differences in the timing of cash flows and expense recognition will continue to be reflected in adjustments to the ROU asset balance. Organizations now have to record both an asset and a liability for their operating leases.

The same journal entry is automatically generated for each of these recurring payments, which greatly reduces the need to review the accuracy of accrued rent entries in each accounting period. If a business owns a property that is not being used then it may decide to rent it out and collect periodical payments as rent. Such a receipt is often treated as an indirect income and recorded in the books with a journal entry for rent received. The other party may post a journal entry for rent paid in their books.

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