Rent expense is the amount a business records as an expense for the use of property it does not own, such as office space, a retail unit, a warehouse, land or equipment, for a given accounting period. It is reported on the income statement as part of operating expenses, or within cost of goods sold or manufacturing overhead when the rented property is used in production.
Under the accrual basis of accounting, rent expense reflects the period in which the property is used, not the date the money is paid. This makes it a classic example of the matching principle and a common subject of adjusting entries. The general meaning of rent as a payment for the use of property is covered in a separate entry.
Journal entries for rent
When rent is paid in the same month as the property is used, the entry is a debit to rent expense and a credit to cash. Timing differences create two other cases:
- Rent paid in advance is first recorded as prepaid rent, a current asset. Each month an adjusting entry debits rent expense and credits prepaid rent for the portion used.
- Rent owed but not yet paid at the end of a period is recorded as accrued rent. The adjusting entry debits rent expense and credits rent payable, a current liability, which is cleared when the payment is made.
Both cases are covered by the end-of-period adjusting entries made before financial statements are prepared.
Worked example
On 1 November, a design studio pays $18,000 for six months' office rent, covering November to April. Its financial year ends on 31 December. On 1 November it debits prepaid rent $18,000 and credits cash $18,000. The monthly cost is $18,000 divided by 6, or $3,000. At 31 December it records rent expense of $6,000 for November and December and reduces prepaid rent to $12,000. The income statement for the year shows rent expense of $6,000 from this agreement, and the balance sheet shows a $12,000 prepaid asset that will be expensed over the next four months.
If instead the landlord bills monthly in arrears and the December invoice of $3,000 arrives on 5 January, the studio still records $3,000 of rent expense in December by accruing it, so that December's results include the cost of using the office that month.
Rent expense and lease accounting
For longer agreements, lease accounting standards change how rent appears. Under US GAAP's ASC 842, effective for public companies from 2019, a lessee records a right-of-use asset and a lease liability for most leases longer than 12 months. For leases classified as operating leases, the income statement still shows a single straight-line lease cost, which many companies continue to label rent expense. For finance leases, the cost is split into amortization of the asset and interest on the liability. Under IFRS 16, effective from 2019, almost all leases are treated like finance leases, so the income statement shows depreciation and interest rather than rent expense. Short-term leases of 12 months or less, and under IFRS leases of low-value assets, may still be expensed as rent.
Straight-line recognition also matters when a lease agreement includes free months or rising payments. A three-year lease with three rent-free months and $4,000 a month thereafter totals $132,000 over 36 months, so the expense recognized is about $3,667 a month from the start, even during the free period.
Classification and tax
Rent for offices is usually reported within administrative expenses, rent for stores and showrooms within selling expenses, and factory rent within product costs that flow into inventory. For US income tax, rent paid for property used in a trade or business is generally deductible, but advance payments are normally deductible only over the period to which they apply, and payments to related parties must be at a reasonable rate.