Mr. Brown got an apartment at the cost of $1000, he paid $3000 to the Landlord. This payment is being referred to as PREPAID RENT because this payment covers his rent for 3 years.
Is Prepaid rent an asset? Of course, it is.
Before explaining how prepaid rent is an asset, I will love to explain the following terminologies :
AssetFixed assetCurrent assetPrepaid asset
Assets:
Assets can be defined as those profitable resources with monetary value that belongs to a person or a firm.
Examples: land and equipment, building, furniture and fittings, stocks and bonds, inventory, and so on
Assets are further classified into Fixed assets and current asset
Fixed asset:
Fixed assets are long-term investments used by the business to leverage its income. Fixed assets are tangible assets, which implies that they can be seen and touched.
Fixed assets depreciate and appreciate due to the passage of time.
Examples of Fixed assets are Land and building, equipment and tools, furniture and fittings, and so on
Current Assets:
Current assets are short investments used in running the business over some time.
Examples of Current assets is Prepaid expenses, stock or inventory, shares, bonds, debentures, account receivables, cash, and so on.
Prepaid rent :
Prepaid rent is a payment made in advance before the rental interval.
Prepaid rent can be classified under current assets because it is an expense covered by an individual or a business in the future, which the business utilizes within a financial year.
It can also be regarded as insurance to protect you against future expenses. You do not have to worry about making another payment.
Illustration of Fixed assets and Current assets using a business model
Mr. George is a business owner who started running his business, with his capital. He bought land and built a structure. He bought furniture for decorations and equipment for productions.
Mr. George went further to an insurance company to ensure his business, against future losses. Insurance is an example of prepaid expenses.
Now, the business must go on. According to the going concern concept in accounting which states that a business is expected to run for a long period or a fiscal period.
Mr. George sold out his company’s shares to shareholders to support the development of his company
From the illustration, it is discovered that Mr. George acquired assets first.
And from the definitions and illustrations above, I hope you can differentiate between Fixed assets and current assets.
Financial accounts for recording prepaid rents ( Journal entry, the Balance sheet, profit, and loss account)
Use of journal entry in recording prepaid rents:
In a journal, every debit entry has a corresponding credit entry.
Assets and expenses are recorded on the debit side of the journal.
Simply follow this rule, “ credit the giver and debit the receiver”.
On the prepaid rent journal, you are expected to record the transaction the debit side .
While on the cash journal, you are expected to record the transaction on the credit side .
Here is a rough sketch of what it looks like,
Debit side _____________Prepaid rent __________Credit side
Cash XX
Debit side _____________Cash _________________Credit side
Prepaid rent XX
The format represents the following:
The prepaid rent journal represents the giver that is being debited. The Cash journal represents the receiver that has been credited.
Use of balance sheet in recording prepaid rent:
A balance sheet is a financial statement that is used to record the total assets and liabilities incurred by a company in a financial year.
Prepaid rents are recorded on the debit side of the balance sheet.
This is because it does not increase or decrease the company’s balance sheet.
Since prepaid rent is a current asset, it is been recorded on the debit side of the balance sheet.
Debit side ______________Balance Sheet __________ Credit side
Capitals XX. Fixed Assets:
Land and building. XX
Current Assets: Current Liability:
Prepaid rent. XX. Accrued rent. XX
Inventory. XX Accrued expenses. XX
XXX. XXX
Use of profit and loss account in recording prepaid rent :
A profit and loss account is a financial statement drafted to ascertain the profit and loss made by the business in a financial year.
In the profits and loss account, prepaid rent is deducted from expenses to ascertain accruals.
Prepaid rent is classified under prepaid expenses, these expenses do not affect the running of the business in any way. But it must be recorded to ascertain the financial position of the business.
The expenses incurred by a business are referred to as Accruals or Accrued expenses. These expenses are incurred within a financial year but they are been paid in the next financial.
Q. Can Prepaid rent be classified under a nominal account?
A. No, it cannot be classified as a nominal account because it is an asset. All assets are classified under real accounts.
Q. Can Prepaid rent be made in form of installments?
A. Yes, depending on the time interval, the terms and conditions of the rent.
Q. If there is an increase in rent in the future, will I still pay?
A. No, you are not expected to make extra payment because an agreement has been signed.
Q. Does prepaid rent affect the business?
A. No, it does not increase or decrease the income of the business.
