Accounting Tutorials – Page 2

A common question you will see in accounting tests is how to deal with rent paid, in particular, the journal entry. In our article today, part of our accounting tutorial series, we will provide you with an example to follow through. And a brief look at the accounting theory involved. For those in a hurry, the journal entry debits the rent expense account and credits the bank account. If you would like some more detail, please read on. Definitions and Conceptual Frameworks Before we get into the journal entry and accounting equation, it is worth touching on what type of transaction is rent paid. Rent paid is an expense to the paying entity; this statement probably being no surprise. But what is an expense? If we turn to the conceptual accounting frameworks, we will find the answer there. I like to use the International Financial Reporting Standards (IFRS) "Conceptual Framework for Financial Reporting". In para. 4.69 the framework defines expenses as: "... decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims." So in our case, we will be decreasing the bank account asset when we pay the rent. Therefore, rent paid is an expense. I know this is stating the obvious to most readers. But having a good understanding of definitions and why we treat transactions a certain way will lay a strong foundation for the complex material that lies ahead. For example, dealing with equity accounting or convertible notes is very difficult without a good grasp of the fundamentals. In this article, we will not be looking at balance day adjustments for rental payments. Please check out the respective links if you want more information on rent paid in advance or accrued rent expense. Journal Entry Example Now onto the fun stuff. If you don't like debits and credits, accounting study is going to be very painful. For this example, we will return to our ABC Ltd. A small privately held company, ABC operates several operations, including earthmoving, landscaping and retail, to the general public. ABC rents storage space for retail business and pays $1,500 a month in advance. In this case, we have to account for the payment of May's rent. The journal entry for this payment would be: DateAccount NameDebitCreditMay 1Rent Expense1,500Bank1,500 The debit to the rent expense increases this balance, while the credit to the bank account decreases this asset. No matter how ABC pays for the rent, the debit will always be to the rent expense account. However, let us say they were able to pay for the rent using a corporate credit card. In this new scenario, the journal entry would be: DateAccount NameDebitCreditMay 1Rent Expense1,500Credit Card1,500 As we mentioned, there is no change to the debt and increasing the rent expense account. But this time, the credit didn't decrease an asset but rather increased a liability. The shift from credit to an asset to a liability still keeps the accounting equation in balance, and this is what we'll quickly look at next. For completeness, the journal entry for the credit card payment would be: DateAccount NameDebitCreditMay 20Credit Card1,500Bank1,500 Accounting Equation In the first scenario, the is paid rent in cash, drawing down on the bank account. So the credit in the journal entry is minus $1,500 in the accounting equation. And the debit to rental expense is plus $1,500. You can see these two entries below, keeping the accounting equation in balance. When starting in your accounting studies, the accounting equation can help determine which accounts you need to be using. By keeping the equation in balance, you are halfway there to solving what to do. In the second scenario, we had a different credit account. So instead of dealing only with the natural debit accounts, we now have to cross over to the right of the equals sign "=". This time the credit is increasing a liability account, the credit card. However, you can see the equation is still balanced, with both sides now growing by $1,500. And to finish off, the payment of the credit card bill still keeps the equation balanced. Conclusion We trust this article helps you better understand how to prepare the journal entry for rent paid. If you have any questions, please use the comments section below, the "ask a question" section or our Contact Us page.