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Prepaid rent includes rent, therefore, you might be thinking that it is an expense, right? Clearing your assumption, that is incorrect. Prepaid rent is a current asset.
In simple words, prepaid rent is recorded under current assets in the balance sheet because often businesses pay the rent before the due date and it is utilized within a few months of its payment, usually within the same financial period. In the balance sheet, all the prepaid expenses that have not yet been consumed are recorded as a current asset about the time frame of one year.
You can think of prepaid expenses as the costs that have been paid but are yet to be utilized. For example, prepaid rent, prepaid insurance, prepaid salaries, etc.
When you make the payment of rent before its due date it is known as prepaid rent. Rent is usually paid in advance for multiple reasons such as availing a discount, is due on the first day of the month, the landlord demands a prepayment, etc. For a better understanding of the concept have a look at the example given below.
Company X signs an agreement to rent a warehouse for 1,000 per month from March for 7 months. The landlord demands payment of the total amount in February. The journal entries to be recorded are as follows:
|Feb||Prepaid Rent a/c||Debit||7,000||Debit the increase in asset|
|To cash a/c||Credit||7,000||Credit the decrease in asset|
(being rent paid)
|March||Rent Expense a/c||Debit||1,000||Debit the increase in expense|
|To prepaid rent a/c||Credit||1,000||Credit the decrease in asset|
(being prepaid rent adjusted as it expires)
Note: The total amount of rent (1,000 x 7) is initially recorded in the balance sheet under current assets as prepaid rent. Each month the asset account is reduced by the amount utilized. You have to decrease the asset account by 1,000 (7,000/7) and record the expense of 1,000.
Prepaid rent as shown in the balance sheet
(Extract of the balance sheet)
Hope this helps.