Prepaid rent

The Prepaid rent (or rent in advance) is an additional good faith sum of money that the tenant puts upfront to finalize the agreement. Prepaid rent is not required or charged by all landlords and is alike more negotiable than the deposit itself. This prepaid rent usually concerns the first, second, or third month of the lease term once the lessee opens for business. Prepaid rent is not a deposit. A deposit or a portion of it is generally held for the entire lease term and when they move out it is returned to the tenant .

Prepaid rent is the example of prepaid expenses .

Companies commonly pay some expenses, including those for insurance, supplies, and rent, in advance. These costs are described as prepaid expenses. By the end of an accounting period, a piece or all of prepaid goods or services will have been used or have expired .

Prepaid Rent In Law Firms

Prepaid rent is ordinarily used by law firms. As year-end approaches, law firms that have had lucrative years often try to find deductions to drop the partnership's taxable income. Because the lower the firm's income allows that the partners pay the less taxes. The rent is one of the largest expense items and that is why it is garnered attention.

Putting aside for the moment the hoped-for tax-saving advantage behind paying rent in advance, there are other reasons that law firms may pay prepaid rent. These include the time when:

1. a lessor insists on remittance of the last year's rent (or some other period at the end of the lease term) as a form of security deposit
2. a cash-flush lessee negotiates an advance payment in order to gain more space or better terms
3. a cash-short lessor provides a considerable discount for paying rent in advance

But even where such non-tax reasons are present, companies hope that advance payment will pass muster as a necessary, typical and ordinary business expenses for tax purposes.

However, if the only business objective of paying rent in advance is to achieve a tax advantage, the chances of having the IRS (Internal Revenue Service) agree that the payment is deductible in the year paid are very small .

Accounting For Prepaid Rent

Tenants are required by some landlords to pay rent in advance. This prepayment generates an asset for the Smart Touch prepays three months' office rent of $3000 ($1000 per month x 3 months) on 1 June 2014. The entry in the register of payment is as follows :

1 June	Prepaid rent (A+)	3000
	Cash (A-)		3000
	Paid rent in advance

After posting, Prepaid rent has a debit balance of $ 3,000.

The trial balance at 30 June 2014 lists Prepaid rent with a $3000 debit balance. During June, Prepaid rent keeps this balance. But $3000 is not the sum of Prepaid rent for the balance sheet at 30 June.

At 30 June, Prepaid rent should be reduced for the amount that has been used up. The used-up part is one month of the three months prepaid, or one-third of the prepayment. Remember that an asset that has expired is an expense. And eventually, the adjusting entry transfers $1000 ($3000 x 1/3) from Prepaid rent to Rent expense.

30 June	Rent expense (E+)	1000
	Prepaid rent (A-)		1000
	To record rent expense

The Prepaid rent is an illustration of an asset that was overstated prior to posting the adjusting entry. We can see the same analysis that refers to the prepayment of three months of insurance. The account titles are the only difference in it. Prepaid insurance would be applied instead of Prepaid rent and Insurance expense would be used instead of Rent expense .

Examples of Prepaid rent

• Prepaid rent can be used to cover the first month of the lease agreement, allowing the tenant to move in before that month's rent is due.
• Prepaid rent can also be used to cover the second and third months of the lease terms in order to give the tenant some extra time to get their business up and running.
• Prepaid rent can also be used as a form of security deposit, to give the landlord assurance that the tenant will be able to pay their rent on time.
• Prepaid rent can also be used to cover the cost of repairs or improvements to the property, such as painting or installing new carpet.
• Finally, prepaid rent can also be used to cover the cost of any fees associated with the lease, such as legal fees or administrative fees.

Advantages of Prepaid rent

Prepaid rent offers many advantages to both the landlord and the tenant. These advantages include:

• Greater financial security for the landlord, as the tenant is contractually obligated to pay a certain amount upfront, regardless of occupancy.
• A higher level of trust between the landlord and the tenant, as the tenant is demonstrating a commitment to the agreement.
• A flexible payment option, as the tenant can pay the prepaid rent over several months.
• Lower rates for the tenant, as the landlord may offer a discount for paying the rent in advance.
• A simpler transition for the tenant, as there is no need to make a separate rent payment for the first month of the lease term.

Limitations of Prepaid rent

Prepaid rent can be a useful tool for landlords to collect additional funds in advance, but it also has certain limitations. These include:

• The prepaid rent may be non-refundable if certain conditions are not met. For instance, if the tenant does not occupy or use the space for which the prepaid rent is intended, the landlord may not be obligated to return the funds.
• In some states, prepaid rent is considered a security deposit, and may be subject to the same legal regulations as a traditional deposit. This can create complications in the event of a dispute between landlord and tenant.
• Prepaid rent may not be appropriate for all tenants, depending on their financial situation. If the tenant cannot afford to pay the prepaid rent, they may need to look for alternative options.
• Prepaid rent may also increase the tenant's financial burden if they decide to move out before the end of the lease term. The tenant may not be able to recoup the cost of the prepaid rent, as they may not be eligible for a refund.

Other approaches related to Prepaid rent

To further expand the concept of Prepaid rent, the following methods can be used to ensure the payment of the lease term:

• Rent Guarantee: A rent guarantee is an agreement between two parties where one party (the guarantor) agrees to be responsible for the payment of rent if the other party (the tenant) defaults. This type of guarantee is usually provided by a third party, such as a bank or an insurance company.
• Rent Escrow: Rent escrow is a process of depositing rent payments into an escrow account to be held by a third party until all conditions of the lease agreement are met. This ensures that the landlord is paid in full and on time.
• Security Deposit: A security deposit is a sum of money that is paid by the tenant to the landlord at the beginning of the lease term and is typically equal to one month’s rent. The security deposit is intended to cover any damages to the property caused by the tenant during their stay.

In conclusion, Prepaid rent is an additional good faith sum of money that the tenant puts upfront to finalize the agreement. Other approaches related to Prepaid rent include rent guarantee, rent escrow, and security deposit.

Footnotes

Prepaid rent — recommended articles

Automatic Premium Loan — Exempt supply — Collateral assignment — Short rate cancellation — Full service leasing — True lease — Bills Payable — Residual payment — Prepaid income

References

• Flood J.M., (2015)., Wiley GAAP 2015: Interpretation and Application of Generally Accepted Accounting Principles
• Horngren C., Harrison W., Oliver S., Best P., Fraser D., Tan R., (2013) Financial Accounting, Pearson Australia
• Needles B.E., Powers M., Crosson S.V., (2011,2008)., Principles of Accounting, South-Western, Cengage Learning
• Quinn J.P., Bailey J.A. (Jr.), Gaulin D.E., Kolodziejczak S., (1986,1994,2001)., Law Firm Accounting and Financial Management, NLP IP Company, Law Journal Press, a division of American Lawyes Media, Inc., New York, New York, United States of America
• Willerton D., Grandfield J., (2013)., Negotiating Commercial Leases & Renewals For Dummies, John Wiley & Sons, Inc., Hoboken, New Jersey, United State of America

Author: Monika Mendak