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It is common in most rental agreements for the landlord to ask for advance rent. Its accounting treatment also differs from the compensation paid in the typical course of the lease. Therefore, it is crucial to understand how it works.
What is Advance Rent?
Advance rent is a common term used in real estate leasing. It refers to the payment of rent by a tenant in advance of the rental period. Typically, it helps secure the rental property before the rental period begins. The advance rent required is usually a portion of the total amount due for the rental period. For example, it may be a percentage of the first month’s or the first and last months’ rent.
Advance rent is a crucial part of the leasing process. Primarily, it helps landlords ensure that their tenants are financially capable of paying rent throughout the rental period. By requiring advance rent, landlords can reduce the risk of non-payment and protect their investment in the rental property. However, advance rent is subject to different regulations and laws depending on the jurisdiction and the terms of the agreement.
What is the accounting for Advance Rent?
Accounting for advance rent involves recording the payment of rent by a tenant in advance of the rental period. When a tenant pays advance rent, it’s initially recorded as a liability on the landlord’s balance sheet because the landlord owes the tenant the use of the rental property for the prepaid period. On the other hand, this rent is an asset for the tenant for the same reason.
The liability gets recognized as unearned revenue on the landlord’s income statement. This treatment occurs because the landlord has not yet earned the revenue from the rental property. As time passes, the landlord earns the revenue, and the unearned revenue account decreases while the revenue account increases. For the tenant, the prepaid amount converts into an expense over time.
What is the journal entry for Advance Rent?
The journal entry for advance rent differs between the tenant and the landlord. However, these entries are the opposite. As stated above, advance rent is a liability for the landlord. When the landlord receives this rent, they must use the following journal entry to record it.
| Dr | Cash or bank |
| Cr | Advance rent |
Over time, as the landlord earns the revenue from advance rent, it must convert the liability to earned revenues. The journal entry for it is as follows.
| Dr | Advance rent |
| Cr | Rental income |
For the tenant, the opposite entries will apply, with advance rent being a prepayment and classifying as an asset.
Example
A landlord leases out property to a tenant for which they receive $2,000 advance rent in cash. This rent is in advance for the first month of the lease period. Therefore, the landlord records the receipt using the following journal entry.
| Dr | Cash | $2,000 |
| Cr | Advance rent | $2,000 |
After the first month, the landlord earns this revenue. Therefore, it converts it to rental income as follows.
| Dr | Advance rent | $2,000 |
| Cr | Rental income | $2,000 |
Conclusion
Advance rent is an amount paid by the tenant before the commencement of a lease agreement. Usually, it covers a portion of the lease for the rental agreement. The accounting for advance rent differs from other compensation paid during this agreement. For the landlord, this advance constitutes a liability and unearned revenue. For the tenant, it is a prepayment and an asset.
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