Deferred Rent - Everything You Need To Know

November 16, 2022

Alok Suman

Lease Management

Knowing the fundamentals of accounting is essential to any company’s success. Under an accrual accounting basis, recording deferred revenues and expenses can help match income and expenses to when they are earned or incurred.

This assists business administrators in accurately assessing the earning statement and comprehending the profitability of an accounting term.

Keep reading to learn about deferred rent, the difference between deferred expenses vs. prepaid expenses, and more.

What is Deferred Rent?

Deferred rent generally occurs when a contract presents a tenant with free rent settlement for one or more than one rent term. This duration is counted from the beginning of the lease contract between the lessee and the property owner in numerous circumstances.

Therefore, many accounting benchmarks demand organizations to document this transaction as 'deferred rent' in their financial accounts. This distinction occurs even if no rent settlements have happened at that moment.

Deferred rent payment allows a lessee to use the owner's premises for one or many rent terms without making the rent settlement. Nevertheless, that does not imply that this entire rent transaction would be free.

The rent contract determines the period until the lessee can use the landlord's premises without making the rental charges. Deferred rent may also arise when a lease agreement concerns varying or differing rental expenses over time.

What are Deferred Expenses?

Deferred expenses, commonly known as prepaid expenses, refer to expenditures that have been settled but not yet incurred by the enterprise.

In addition, common prepaid expenditures may incorporate monthly rent payments or insurance settlements that have been expended in advance.

For instance, a company that offers bonds to raise funds incurs hefty expenditures during the bond distribution procedure.

These expenses may comprise legal charges to prepare official documents, investment banking costs for the underwriter, or expenses related to other accounting services, adding to hundreds and thousands of dollars for the business. This debt distribution price can be classified as a deferred expenditure.

An Overview of Deferred Expenses vs. Prepaid Expenses

Businesses can settle their enterprise expenditures ahead of specific expenses associated with performing corporate operations. In addition, it can pass an accounting entry on the company's balance sheet under the head as a deferred or prepaid expenditure.

Deferred and prepaid expense payments are documented on a business's balance sheet for accounting objectives and also impact the business's financial statement during a journal entry.

As a company cannot immediately profit from the investments made, all the prepaid and deferred rent expenditures are documented as assets on the balance sheet until the payment is realized.

Key Differences Between Deferred Expenses and Prepaid Expenses

While both deferred and prepaid expenses are categories of advance payments, there are some notable distinctions between these accounting terminologies.

The assets and liabilities sides on a company's balance sheet both customarily distinguish and split the components of deferred and prepaid expenses between current and long-term.
Most financial managers refer to deferred expenses that will become overhead costs within one year as specified in the company's balance sheet as prepaid expenses.
The sum that has not been settled as per the date mentioned in the balance sheet will move to the current assets section.
On the other hand, deferred expenditures that will not become overhead costs within one year of the date specified in the balance sheet will move to the long-term asset section in the company's financial statement.
One exception to this entry is when a company issues a bond as it gets recorded under the contra liability account head in the balance sheet.
When the time period of the payment suspension is less than one year, this expense gets recorded as a "prepaid expense."

Final Thoughts

Even when there are considerable differences between deferred and prepaid expenses, they usually perform an exceptionally important role for any business. It helps them organize their finances adequately and help document these expenses and revenue items in the financial statements in an objective and timely fashion.