Prepaid Expenses Balance Sheet Accounting + Examples

Keep in mind that some jurisdictions have laws limiting how much landlords can collect in prepaid rent. So be sure to check your local laws before collecting any prepaid rent from your tenants. For example, assume you sign a 12-month lease with a tenant on May 1 and receive $1,000 in rent for May and $1,000 for the last month of rent for April of the following year. If you collect first and last month’s rent from your tenants, you must be transparent about why you’re doing it and ensure your tenants understand the risks involved. Pre-paying expenses may or may not be a worthwhile effort for your company. First and foremost, examine your business’s cash flow to see if you even have the means to prepay expenses before you sweat the decision. Note that you can record the entire expense in the current period even if the contract expires in a future period.

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Prepaid Expenses Example

Prepaid rent is an asset – the prepaid amount can be used by the entity in the future to reduce rent expense when incurred in the future. Prepaid expense amortization is the method of accounting for the consumption of a prepaid expense over time. This allocation is represented as a prepayment in a current account on the balance sheet of the company.

If this is not done, the financial statements would over-report the asset and under-report the expense. Hence, in order to prevent this, it is advisable for the bookkeeper to keep track of the contents of the prepaid rent account. It is best that the prepaid rent account is reviewed before closing the books What is Prepaid Rent? – Basic Accounting Help at the end of each month. When looking at the definition of an asset, recall that an asset is considered to be something that provides a current, future, or potential economic benefit for an individual or company. It is something that is owned by the company or something that is owed to the company.

Prepaid Rent Vs. Rent Expense

As the benefits of the advanced rent payment are realized over time, the prepaid rent value is decreased, and the amount is expensed to the income statement. Therefore, prepaid rent is first recorded on the balance sheet, in the prepaid expense/asset account because it represents a future benefit that is due to the business. It is recognized as a current asset because https://business-accounting.net/ it is expected to be consumed, used up, or expired through standard business operations within one year. A company can make an advance payment for a good or service such as rent for leased office space or insurance coverage that gives continual benefits over time. Such prepayments are known as prepaid expenses which are made in advance for future benefits.

Prepaid expenses usually relate to the purchase of something, such as rent or insurance, that provides value to the business over several accounting periods . The business records a prepaid expense as an asset on the balance sheet because it represents a future benefit due to the business. As the benefits of the good or service are realized over time, the asset’s value is decreased, and the amount is expensed to the income statement. In January, the company records a journal entry to recognize 1/12 of the value of the insurance policy. The journal entry debits an insurance expense account and credits prepaid expenses for $1,500. At the end of January, the prepaid expense account balance is $16,500 on the balance sheet. The January month-end income statement reports $1,500 as the current period insurance expense.