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What is Deferred Rent?
Deferred rent usually arises when a rent agreement grants a tenant free rent for one or several periods. In most cases, this period falls at the start of the lease agreement between the tenant and landlord. Accounting standards require companies to record this transaction as deferred rent. This recognition happens even if no payments have occurred at that time.
Deferred rent allows a tenant to use a property for one or several periods without paying rent. However, that does not make the transaction free. The rent agreement specifies the time until the tenant can use the property without rental payments. Deferred rent may also occur when a lease contract involves inconsistent or changing rental fees over time.
What is the accounting treatment of Deferred Rent?
Practically, deferred rent is straightforward. In accounting, however, the same does not apply. When a company receives rent for free, it falls under the definition of income. However, accounting standards do not allow this treatment. Instead, companies must record the deferred rent as a liability on the balance sheet. As rent expense payments occur, companies must set them off with the deferred rent recorded earlier.
However, companies cannot use the deferred rent to set off rent expenses for one period. Accounting standards require them to spread the free rent over the length of the lease agreement. Once the lease period is over, the deferred rent expense will report a zero balance. On the other hand, the rent expense for each period during the lease agreement will be lower than the actual payment.
What are the journal entries for Deferred Rent?
The journal entries for deferred rent occur in two stages. When the lease agreement starts, companies must record a rent expense for the free months. Companies can calculate this expense as follows.
Average rent expense = Total rent expense / Total lease period
Once calculated, companies use the following journal entry for the free months.
| Dr | Rent expense |
| Cr | Deferred rent |
The above journal entry will be for the same amount as the average rent expense calculated above. For the periods where actual payments occur, companies spread the deferred rent recorded earlier. As stated above, it decreases the rent expense for each period. This journal entry will also account for the actual payment as follows.
| Dr | Rent expense |
| Dr | Deferred rent |
| Cr | Cash |
Example
A company, Red Co., signs a lease agreement for 12 months. The landlord grants the company free rent for the first two months. For the subsequent months, Red Co. must pay $1,200 in rent each month. Therefore, the company must account for the deferred rent. Red Co. calculates the average rent expense first, as follows.
Average rent expense = Total rent expense / Total lease period
Average rent expense = ($1,200 x 10) / 12
Average rent expense = $1,000
For the first two months, Red Co. uses the following journal entries.
| Dr | Rent expense | $1,000 |
| Cr | Deferred rent | $1,000 |
The above journal entries are for the free months. For the remainder of the contract, Red Co. uses the following journal entries to record the rent expense.
| Dr | Rent expense | $1,000 |
| Dr | Deferred rent | $200 |
| Cr | Cash | $1,200 |
Conclusion
Deferred rent occurs when a lease contract involves inconsistent payments. Practically, it applies more when lease agreements grant a tenant free rent for one or several periods. However, this feature complicates the accounting for the rent expense and deferred rent. Companies can use the guidance provided by accounting standards to tackle this issue.
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