In lease accounting, deferred rent happens when the cash rental payment varies from its recognized financial statement and occurs when the tenant is provided free rent in one or more periods. Here is everything you need to know about deferred rent ASC 840 rules.
What Kind of Account is Deferred Rent?
Deferred rent is a balance sheet account traditionally used in legacy accounting standards as defined in ASC 840. It is the liability coming from the difference between the actual amount paid and the straight-line expense declared in the financial statements of the lessee.
The ASC 840 requires the total rent expense to be recognized on a straight-line basis during the lease period even if rent payments differ. The debiting or crediting of the deferred rent account monthly allows the lessee to approximately record the rent expense using the straight-line basis and catch whatever difference is between the amount paid and the expense recognized in this account. The cumulative balance of the deferred rent when the lease is terminated has to be equal to zero.
Where is Deferred Rent on the Balance Sheet?
A deferred rent can be an asset or a liability in the balance sheet depending on the payment schedule. The deferred rent becomes an asset if the difference between the rent expense and rent payment is negative. It becomes a liability if the difference is positive.
What is the Accounting for Deferred Rent?
Accounting for the free rent period and subsequent periods are as follows:
Add the total cost of the rent payments for the entire lease period. For example, if the lease term is one year with first-month rental being free and the rental rate for the rest of the months is $1000, then the total rental cost is $11,000
Divide the total rental cost by the total number of periods in the lease contract including the free rental month. In our example, we will divide $11,000 by 12 months and get $917.
Each month of the lease, the average monthly rate should be charged as an expense, regardless of whether there was an actual payment made. In our example, the expense for the first month is $917 even if there is no actual payment since the tenant did not pay for the first month. This means that the $917 debited to expenses is offset by a credit to the deferred rental account, which becomes a liability account.
For the remaining months of the lease, the same average amount should be charged as an expense. This is $917 in our example. Should there be an offsetting of the rental payment and if the payment and expense don’t match, then the difference should be charged to the liability account
In our example, the monthly payment for the remaining period after the free month has lapsed is still $1,000, an amount that’s higher by $83 than the amount charged as rent expense, which is $917. This difference should be used to reduce the amount of the deferred rent liability during the remaining months of the rental period until it becomes zero.
The same accounting approach should be used even if the rental amount changes throughout the lease period. For example, if the lease rate increases in the succeeding months, then the average rent expense should be charged in all months with a portion of it forming part of the rent liability.
What is the Difference Between Prepaid Rent and Deferred Rent?
There’s a difference between deferred rent vs prepaid rent. The former is when the lessor provides free rent usually at the start of the lease term. On the other hand, prepaid rent is a future expense to be paid by the business.
How ASC 842 Transition Affects Deferred Rent Accounting
The concept of straight-line rent expense on operating leases was retained despite the transition to the ASC 842. But under the new mechanics, the deferred rent should be replaced by the Right of Use (ROU) asset and lease liability accounts. The ASC 842 guidelines are much more complicated than its predecessor, ASC 840. Thus, any lease accounting software must have ROU Asset functionality in place. It is best to go for trusted accounting software such as ours.
At Visual Lease, we make compliance to ASC 842 and other standards a breeze. To learn more about how Visual Lease can help your business contact us now.