Accounting for Discounted Rent Period

[cupcake_queen]

Any help would be much appreciated on this problem with a discounted rent free period accruals problem.

Rent is £95k per annum for 5 years. 9 months is half price. I have worked out that there is £35625 reduction to spread over 5 year which is £593.75 per month.

I know that this must be released as DR BS Accruals Account and CR P&L Rent £593.75.

My question is that I know that I have to CR the BS accrual account with the £35625 but what do I DR and why?

Rent is paid on a quarterly basis and transferred to prepayments where I release it on a monthly basis.

Thanks

 

[Samir]

What do you initially DR when CR BS Accruals? I would CR that account because while your BS Accruals has reduced, it is not because of the usual CR to P&L Rent. The money is not having to be spent, so it can go back where it came from.

For example:

Initial Quarterly Payment
CR Bank Account
DR BS Accruals

Monthly release (expensing)
CR BS Accruals
DR P&L Rent

Discount Applied (with refund)
CR BS Accruals
DR Bank Account

If you aren't getting a refund of any amount, or it wasn't paid this way in the first place, then the amount in BS Accruals should reflect what you actually paid, not the non-discounted rent amount (which you then have to adjust).

 

[Counterofbeans]

What do you initially DR when CR BS Accruals? I would CR that account because while your BS Accruals has reduced, it is not because of the usual CR to P&L Rent. The money is not having to be spent, so it can go back where it came from.

For example:

Initial Quarterly Payment
CR Bank Account
DR BS Accruals

Monthly release (expensing)
CR BS Accruals
DR P&L Rent

Discount Applied (with refund)
CR BS Accruals
DR Bank Account

If you aren't getting a refund of any amount, or it wasn't paid this way in the first place, then the amount in BS Accruals should reflect what you actually paid, not the non-discounted rent amount (which you then have to adjust).

No.


The answer is simple: You need to straight line your rent expense. Add up the total cash that will be paid for rent and then divide by 60 (i.e. 5 years). This is your monthly rent expense. The difference between what you actually pay vs. this calculated rent expense goes into a deferred liability account, like deferred rent, which represents a liability. If you do your accounting correctly, this will be zero at the end of the lease/rent agreement.

You don't need to do a single thing with "prepayments," nor the £35625 you calculated. Simply Dr. Rent Expense, Cr. Accrued Liabilities until your quarterly payment comes due, make the payment & you're good to go.

The "accounting" answer would be to Dr. Accrued Liabilities and Cr. Cash when the rent payment is made. In the "real world," however, this is seldom done, as we don't want to disrupt the standard procedures in the AP department. As such, we would simply book the accrued rent on a reversing JE, AP records the expense into the appropriate Rent Expense account, the check is cut and the world is a happy place.

 

[Samir]

No.


The answer is simple: You need to straight line your rent expense. Add up the total cash that will be paid for rent and then divide by 60 (i.e. 5 years). This is your monthly rent expense. The difference between what you actually pay vs. this calculated rent expense goes into a deferred liability account, like deferred rent, which represents a liability. If you do your accounting correctly, this will be zero at the end of the lease/rent agreement.

You don't need to do a single thing with "prepayments," nor the £35625 you calculated. Simply Dr. Rent Expense, Cr. Accrued Liabilities until your quarterly payment comes due, make the payment & you're good to go.

The "accounting" answer would be to Dr. Accrued Liabilities and Cr. Cash when the rent payment is made. In the "real world," however, this is seldom done, as we don't want to disrupt the standard procedures in the AP department. As such, we would simply book the accrued rent on a reversing JE, AP records the expense into the appropriate Rent Expense account, the check is cut and the world is a happy place.

Good point about the liability, but rent is paid in advance a quarter at a time, so you have an asset when that has been paid and not applied. What do you with this scenario (which is the OP's scenario)?

 

[Counterofbeans]

Good point about the liability, but rent is paid in advance a quarter at a time,

It is? Did I miss something?? Either way, it doesn't really do much of anything

so you have an asset when that has been paid and not applied. What do you with this scenario (which is the OP's scenario)?

It doesn't matter when the monthly/quarterly cash payment is made. He simply Dr Prepaids when the payment is made and releases 1/3 of it, via a debit, to the corresponding Deferred rent liability account on a monthly basis (i.e. Dr. Deferred Rent, Cr. Prepaids).

Then, he simply Dr Rent expense for the straight line expense that's calculated and Cr. the corresponding Deferred Rent liability account and the world is a happy place.

Ultimately, the Deferred Rent liability account should represent the difference between the calculated, straight-line rent expense vs. the actual cash flows. Since these only become equal at the end of the lease, this is the only time that the deferred rent account will become zero. I generally do this calculation in Excel and I can prove out the deferred rent account at any time.

 

[Samir]

It is? Did I miss something?? Either way, it doesn't really do much of anything

Yes I think you did.

Rent is paid on a quarterly basis and transferred to prepayments where I release it on a monthly basis.

I don't understand how you can say it doesn't make a difference. Rent paid, but not expensed at the time of payment has be accounted for somewhere.

It doesn't matter when the monthly/quarterly cash payment is made. He simply Dr Prepaids when the payment is made and releases 1/3 of it, via a debit, to the corresponding Deferred rent liability account on a monthly basis (i.e. Dr. Deferred Rent, Cr. Prepaids).

Then, he simply Dr Rent expense for the straight line expense that's calculated and Cr. the corresponding Deferred Rent liability account and the world is a happy place.

Ultimately, the Deferred Rent liability account should represent the difference between the calculated, straight-line rent expense vs. the actual cash flows. Since these only become equal at the end of the lease, this is the only time that the deferred rent account will become zero. I generally do this calculation in Excel and I can prove out the deferred rent account at any time.

I think I'm almost following you. Could you show a sample payment and the respective t-charts for all the JEs?

 

[Counterofbeans]

Yes I think you did.

No. Where does the OP say that rent is paid in advance?

I think I misread it when I first went through that post though.

But, even if it is paid in advance, it doesn't make any difference on the P&L. See comment below

I don't understand how you can say it doesn't make a difference. Rent paid, but not expensed at the time of payment has be accounted for somewhere.

It is accounted for somewhere, in prepaid expenses, as stated above. When the cash is paid, however, has no bearing on the P&L impact.

I think I'm almost following you. Could you show a sample payment and the respective t-charts for all the JEs?

Given:
Rent = $200/month, first month is free
6 month lease
Rent is paid one month in advance

Solution:

5 months at $200 = $1,000 total rent to be paid. $1,000 / 6 month lease term = ~$167.

At the close of month 1:

Dr. Rent Exp $167
Cr. Def Rent $167

Also, sometime during month 1, you paid the rent with:

Dr. Prepaid exp $200
Cr. Cash $200

At the close of month 2:

Dr. Def Rent $200
Cr. Prepaid exp $200

Dr. Rent Exp $167
Cr. Def Rent $167

And so on and so on.

At the end of month 6, the deferred liability account you initially set up in month 1 will go to zero. Note how rent expense is the same throughout the lease period.