What is Rent Expense?
Rent expense refers to the total cost of using rental property for each reporting period. It is common among the largest expenses that companies must report. Only two expenses are typically larger than rental expense: cost of goods sold (COGS) and compensation expense.
Rent expense explains how much cash was handed over during the reporting period. It is a representation of how much a rental property was used. The expense is generally divided – on the income statement – between the production and selling and administrative sections. Also, it is sometimes listed in the selling and administrative section of the income statement.
- Rent expense is commonly one of the largest accounts a company reports.
- How a rental space is used affects what account the rent expense is listed under.
- A deferred rent expense account must be used if a company does not pay a consistent price per month for its rental space.
Accrual Basis of Accounting
With the accrual basis of accounting method, any revenue is listed on the income statement upon earning it, even if the cash hasn’t actually been received yet.
For rental expense under the accrual method, when rent is paid ahead of schedule – which happens rather often – then the rent is recorded in the prepaid expenses account as an asset. Once the business moves into the rental space, the rent expense is then moved to the expense column.
Deferred Rent Expense
Across the board, companies are supposed to have a consistent rent expense documented every month. It is dictated in the generally accepted accounting principles (GAAP). The major problem with the regulation is that rent expenses aren’t always consistent. In many cases, because of inflation, monthly rent expense increases over time. On the other hand, the lessor might give the company a “first month free” offer or offer a free month or a break on rent for different reasons.
In order to deal with the situation, the balance sheet must also include a deferred rent expense account. The account must:
- Determine the cost of the lease for its entire period, including free months, discounted months, or months that go up because of inflation
- The amount must then be divided by the total number of months covered under the lease
- Every month must be listed under the original monthly rental expense, regardless of what was actually paid. It is listed in the expense account.
- Offsetting rent payments – reduction of cost or inflation of cost – is listed in the deferred rent expense account.
How Rental Space Is Used
Rent expense can, in fact, be listed in a number of different places. It depends entirely on how a company intends to use the rental space. It is often, as mentioned above, listed as a selling or administrative expense. If, for example, the space was used as a place to manufacture goods, the expense would then be listed as part of the cost of goods sold (COGS) for the products produced.
Location, Location, Location
For companies, location is everything, especially for real estate and retail companies. It’s important to be located in a place with a lot of foot traffic and access to the company’s target consumer base. Companies often allocate a large part of their rental expense towards prime locations. For such companies, it’s crucial to weigh the cost of the rent against the benefits and potential boost in revenue that comes from being in a prime location.
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