Prepaid rent is an advance payment on a lease of property. The amount of the prepayment is carried on the books of the business leasing the property as a current asset account that will be expensed at some point in the future. As the business does its bookkeeping, the prepaid rent expense account allows the bookkeeper to track the value of the asset until such a time that the amount in the account is spent.
All businesses must maintain bookkeeping records to meet tax and other regulatory obligations. The business will periodically generate a set of financial statements to summarize its financial position. These statements conform to a set of generally accepted accounting principals that standardize financial reporting so businesses can be compared to one another against a common backdrop. Standard accounting conventions specify how to carry outstanding rent deposits for a lease on the books until such a time as the deposit is actually applied as payment for a month’s rent.
A rental agreement to lease property is considered a tangible asset. When a business enters into such an agreement, it often has to pay not only the current month’s rent but also a certain number of months in advance as security for performance under the agreement. This security deposit can be refundable at the end of the lease upon the satisfaction of certain conditions or treated as a nonrefundable prepayment that pays the months at the tail end of the agreement. Whether the security deposit is refundable or non-refundable determines how the amount is treated for bookkeeping purposes.
Non-refundable rent payments that cover the rent for future months are carried on the books of the owner of the property as deferred unearned revenue. The amount is carried on the books of the business renting the property in the prepaid rent expense account. This account is capitalized, or decreased, when an amount of prepaid rent is actually applied to pay for a month’s rent.
This accounting convention is particularly important when generating a balance sheet. A balance sheet is a summary of the financial position of a company at a specific moment in time. Rent deposits can apply to months that are years in the future. Until the amount is actually applied in payment for a month’s use of the leased property, it must be properly represented as a current asset when the company generates its financial statements. The prepaid rent account allows the company to show that it has a current asset that will benefit the company at a future date.