Rent is one of the largest expenses that companies face, and it’s critical to properly account for it. Under ASC 842, rent is accounted for in two different ways: accrued rent and deferred rent. In this post, we will explore what these terms mean, the difference between them, and what to keep in mind when it comes to rent accounting under ASC 842.
What is the Difference Between Deferral and Accrual?
- Accrual: Recognizing expenses or revenues when they are incurred, regardless of cash flow.
- Deferral: Postponing recognition of expenses or revenues to a later period when they align with economic activity.
What is Accrued Rent?
Accrued rent is a rent expense that has been recognized but not yet paid. It represents the difference in timing between paying rent and the actual cash payment of rent. In a traditional straight-line application, rent is expensed equally across the lease’s entire term. However, the actual rent payments made may vary depending on the lease agreement. In some cases, the rent may be expensed when no rent is paid, resulting in accrued rent.
Example of Accrued Rent
Imagine a company leases office space at $10,000 per month, with rent payable at the end of each quarter. At the end of the first month, the company records $10,000 in rent expense, even though no payment is due yet. By the end of the quarter, accrued rent totals $30,000, which is then cleared when payment is made.
ASC 842 Impact on accrued rent
Accrued rent was a liability under the ASC 840 methodology, but under ASC 842, there is no accrued rent. This is because there is already an asset and a liability recorded for the lease.
What is Deferred Rent?
Deferred rent is the difference between the amount of rent paid and the rent expense. In a straight-line rent application, the rent paid in the early months of the lease is less than the rent paid in later months. This results in deferred rent, which is recorded as a liability on the balance sheet.
Example of Deferred Rent
A company signs a five-year lease for equipment, starting at $1,000 per month in year one, with rent increasing by $100 each year. Although payments rise annually, expense is recognized evenly across the lease term. In early years, the company records less expense than cash paid, and the difference accumulates as deferred rent.
ASC 842 Impact on Deferred Rent
Under ASC 842, deferred rent is not tracked in a separate liability account. Instead, the timing differences flow through the measurement of the ROU asset and Lease Liability, ensuring that expense is recognized consistently while cash flow variations are properly accounted for.
Accrued Rent vs. Deferred Rent: What’s the difference?
Accrued rent and deferred rent are both accounting concepts that relate to the timing of rent payments and rent expense recognition, but they represent different scenarios. Accrued Rent represents a difference in timing, whereas Deferred Rent represents a difference of amount in the period.
Under ASC 842, accrued rent is not recognized separately as a liability because the right-of-use asset recognized on the balance sheet already reflects the straight-line rent expense. The difference between the right-of-use asset and lease liability represents the deferred rent or prepaid rent.
| Aspect | Accrued Rent | Deferred Rent |
| Definition | Expense incurred but not yet paid (or recognized by landlord but not received) | Difference between straight-line rent expense and cash paid |
| Timing | Short-term, often due to payment schedules (e.g., quarterly billing) | Longer-term, common with step-up leases or rent holidays |
| ASC 840 Treatment | Recorded as a liability | Recorded as a liability |
| ASC 842 Treatment | Captured in ROU asset and Lease Liability, not separate | Captured in ROU asset and Lease Liability, not separate |
Key Considerations for Rent Accounting under ASC 842
Rent accounting under ASC 842 can be complex and requires careful consideration. Here are some key things to keep in mind:
- Identify lease arrangements: The first step is to identify all lease arrangements, including embedded leases, and determine if they meet the criteria for recognition under ASC 842.
- Determine lease term: The lease term is the period during which the lessee has the right to use the leased asset. It includes the non-cancellable period of the lease plus any periods covered by options to extend or terminate the lease if they are likely to be exercised.
- Determine lease payments: Lease payments include fixed payments, variable payments based on an index or rate, and any other amounts the lessee is required to pay under the lease. Not all are included in the calculation of the Lease Liability and Right of Use Asset. The details of the lease agreement and your accounting elections will determine the proper payments to include.
- Calculate lease liability: The lease liability is the present value of lease payments, discounted using the lessee’s incremental borrowing rate. Private business entities have the option to use a risk-free rate in place of the incremental borrowing rate. This represents the obligation to make lease payments over the lease term.
- Calculate right-of-use asset: The right-of-use asset is the lease liability plus any initial direct costs and lease payments made before the lease commencement date. Lease incentives, deferred, and accrued rent can also impact the right-of-use asset value. It represents the lessee’s right to use the leased asset over the lease term.
- Recognize lease expense: If the lease is an operating lease, the lease expense is recognized on a straight-line basis over the lease term, unless there is a more appropriate basis for allocation. If the lease is a finance lease, the lease expense is recognized as straight-line amortization of the right-of-use asset plus the period interest expense.
Challenges in Managing Accrued & Deferred Rent
Managing accrued and deferred rent can be complex, especially for businesses with multiple lease agreements and long-term commitments. One common Common challenges include:
- Ensuring that rent schedules align with actual payment timelines
- Accrued rent requires companies to record rent expenses as they are incurred, even if payment has not been made
- Deferred rent involves recording payments that are delayed to a future period
- Accurately tracking changes in rent agreements, such as rent holidays or lease modifications, which can affect how accrued and deferred rent are reported
- It is important to be compliant with lease accounting standards, as improper reporting of these can lead to misstatements
Implementing strong internal controls and regularly matching rent schedules with financial reports can help reduce these challenges.
How Lease Accounting Software Can Help Manage Accrued & Deferred Rent
Lease accounting software can help simplify the management of accrued and deferred rent. Tools like Visual Lease help organizations:
- Track rent schedules across portfolios
- Automate recognition of incentives, step-ups, and deferrals
- Maintain accurate lease liability and ROU asset balances
- Reduce manual errors and simplify reporting under ASC 842
Visual Lease accounting software provides insights into lease payments, liabilities allowing companies to manage their rent obligations efficiently. The software can also automate the application of lease incentives, rent holidays, and modifications, helping maintain accurate financial records while improving overall lease management.
Overall, rent accounting requires a detailed analysis of lease arrangements, lease terms, and lease payments, as well as careful consideration of transition requirements. It is important for entities to have efficient processes and systems in place to ensure compliance with accounting standards.
Frequently Asked Questions about Accrued and Deferred Rent:
What is a rent expense?
Rent expense is the cost recorded for using leased property or equipment during a reporting period. Under ASC 842, it is typically recognized on a straight-line basis even when cash payments vary.
What is straight-line rent?
Straight-line rent spreads total expected lease payments evenly across the lease term. It produces consistent periodic expenses despite step-ups or free-rent periods.
How does deferred rent work?
Deferred rent arises when cash paid differs from straight-line expense in a period. Under ASC 842, those differences adjust the ROU asset and Lease Liability rather than a separate deferred rent account.
What is a deferral agreement?
A deferral agreement is an arrangement where the landlord and tenant agree to postpone rent payments. If it significantly changes payment timing, it may be treated as a lease modification under ASC 842.
