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Landlords often demand tenants pay them rent in advance. For the tenant, it is a prepayment or asset. However, the landlord must recognize it as unearned rent. Before understanding the accounting treatment, it is crucial to know what unearned rent is.
What is Unearned Rent?
Unearned rent, or deferred rent or rent received in advance, is a liability account in accounting that represents rent payments that a tenant has made in advance but has not yet qualified as earned by the landlord. This situation typically arises in lease agreements where tenants pay rent in advance for a future period, such as the next month or quarter.
From the landlord’s perspective, unearned rent is a liability because the landlord has not yet delivered the service that the tenant has paid for. As time progresses and the landlord provides the agreed-upon rental services, the unearned rent liability decreases, and an equivalent amount gets recognized as rental income on the landlord’s income statement. This process continues until the entire advance payment has been earned.
What is the accounting for Unearned Rent?
The accounting treatment for unearned rent is a structured process aimed at accurately reflecting the receipt and recognition of rental income. When tenants make advance rent payments, landlords initially record the full amount received as a liability on the balance sheet under an account called “Unearned Rent” or “Deferred Rent.” It signifies the landlord’s obligation to provide rental services for future periods.
As time progresses, typically every month, portions of the unearned rent liability are recognized as rental income on the income statement. The amount recognized corresponds to the rental service provided during that specific month. This gradual recognition continues until the entire advance payment qualifies as earned, at which point the unearned rent liability becomes zero.
What is the journal entry for Unearned Rent?
The journal entry for unearned rent involves two stages. The first occurs when a landlord receives cash from a tenant for the underlying property in the future. At this stage, the landlord has not earned the rent. Therefore, they cannot record it as income. As stated above, they must recognize a liability instead. The landlord can use the following journal entry to do so.
|Dr||Bank or cash|
|Cr||Unearned or deferred rent|
The second stage for the journal entry for unearned rent is once the tenant uses the property for that period. At this stage, the payment becomes “earned” for the landlord. Therefore, they can unrecognize the liability and recognize the income instead. The landlord can use the following journal entry to do so.
|Dr||Unearned or deferred rent|
A company, Blue Co., owns a property that it rents to a tenant. The monthly rent for this property is $2,000. Under the lease agreement, the tenant must pay six months’ rent in advance. Therefore, Blue Co. receives $12,000 at the start of its bank account of the lease agreement. At this stage, Blue Co. records the receipt as follows.
After every month, Blue Co. recognizes a portion of the payment as rental income. For each month, the amount of earned rent is $2,000. Blue Co. uses the following journal entry to record it.
Unearned rent refers to payment a landlord receives for the future use of an underlying property. This rent only becomes “earned” once the rent period passes. In other words, it becomes income to the landlord once the tenant has used the property. Before that, any payments received are recognized as a liability on the balance sheet.
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