Not an uncommon question we see come up around prepaid rent is the question “is it an asset or a liability?”. The answer, of course, depends on whether you are the tenant or the landlord – and its today focus in our accounting tutorial series.
If you are relatively short on time, the answer is if you are the tenant, it is an asset, and if you are the landlord, it is a liability. If you would like further details, please read on.
What is Prepaid Rent?
As we stated above, the answer of asset or liability depends on whether you are the tenant or the landlord. So let’s look at both below.
Why is Prepaid Rent an Asset?
Prepaid rent is an asset for the tenant because they are owed a bunch of economic benefits (i.e. the use of the property) due to paying for the rent in advance. Under current accounting conceptual frameworks, this meets the definition of an asset – it’s that simple.
We like to go to the International Financial Reporting Standards (IFRS) Conceptual Framework for our reference point in definitions. It defines an asset as “… a present economic resource controlled by the entity [or person] as a result of past events” (para 4.3). The framework goes onto defining an economic resource as “… a right that has the potential to produce economic benefits” (para. 4.4).
Over the last few decades, the focus of these conceptual frameworks has been very on assets and liabilities – rather than income and expenditure as they use to. This approach makes the classification of transactions much more straightforward in many ways. As in our case with prepaid rent, the tenant has an asset (most if not all of it a current asset) because their payment creates a bundle of economic benefits in the form of having control over the use of a property for a specific period.
Why is Prepaid Rent a Liability?
Let us now turn to the landlord and see why they have a liability (of course, it makes “natural sense” if the tenant has an asset … but let’s check it out anyway). The IFRS Conceptual Framework referenced above defines a liability as “… a present obligation of the entity to transfer an economic resource as a result of past events” (para 4.26). So yes, it just takes the opposite side to the asset discussion above.
In our case, the landlord has a bundle of economic obligations that provide the tenant control of the property for the period covered by the prepayment.
Prepaid Rent Asset and Liability Example and Journal Entries
The first journal entry below is that for the tenant. Let us assume our beloved example company, ABC Ltd, was offered an excellent discount to pay rent upfront on a new storage unit they needed for the next six months. We are going to ignore any discount received in this example and record the actual rent paid. The net price per month for a six-month contract is $1,000. So the journal entry for the ABC accounts team is:
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| July 10 | Prepaid Rent | 6,000 | |
| Bank | 6,000 |
The debit entry creates the prepaid rent current asset for ABC. And the credit reflects the reduction in their bank balance with the $6,000 going to their new landlord.
If you would like more detail on how to treat prepayments, check out our tutorial here.
Now for the landlord. The journal entry, unsurprisingly, is the opposite of the above one ABC Ltd made. The landlord would record:
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| July 10 | Bank | 6,000 | |
| Revenue in Advance | 6,000 |
The debit entry increases the bank current asset as the landlord now has the cash. At the same time, the credit creates a liability with the use of the revenue in advance current liability account. If you would like more information on income received in advance (often called unearned revenue), check out our tutorial here.
Conclusion
We trust this article helps answer the question for you regarding whether prepaid rent is an asset or liability. We have a growing range of accounting tutorials on the site; please let us know what you think.