The total cost of using rental property for each reporting period
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
What is Rent Expense?
Rent expense refers to the total cost of using rental property for each reporting period. It is typically among the largest expenses that companies report. Only two expenses are usually larger than rental expense: cost of goods sold (COGS) and compensation (wages) expense.
Rent expense is the payment made to a landlord for the rental space that is used by the company. For manufacturing companies the expense is generally divided – on the income statement – between the production and selling & administrative business units. It may sometimes simply be listed in the selling & administrative section of the income statement.
Summary
- Rent expense is commonly one of the largest expenses a company reports.
- How a rental space is used affects what account the rent expense is listed under.
- Deferred rent is when a company is given one or more periods of free rent usually at the beginning of a new lease agreement.
Accrual Basis of Accounting
With the accrual basis of the 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, or time passes so that the expense becomes current, then the rent expense is then moved to the expense column.
Deferred Rent Asset or Liability
Across the board, companies are supposed to have a consistent rent expense documented every month. This is dictated in the generally accepted accounting principles (GAAP). The major problem with this regulation is that monthly rent payments aren’t always consistent. In many cases, because of inflation, for example, monthly rent expense increases over time. On the other hand, the lessor might sometimes give the company a free month or a discount on the rent.
In order to deal with this situation, the balance sheet must include a deferred rent asset or liability account. This 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 that month. It is listed in the expense account.
- Offsetting rent payments – reduction of cost or inflation of cost – is listed in the deferred rent asset or liability account.
How Rental Space Is Used
Rent expense can, in fact, be listed in a number of different places in a company’s financial records. 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.
More Resources
Thank you for reading CFI’s guide to Rent Expense. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:
Sure, I'm well-versed in accounting principles and financial analysis. Rent expense, as outlined in the article, refers to the total cost incurred by a company for utilizing rental property within a specific reporting period. It stands as one of the significant expenses companies report, often ranking among the largest, trailing just behind expenses like cost of goods sold (COGS) and compensation (wages).
The utilization of a rental space varies among companies, influencing how the rent expense is categorized within their financial statements. For manufacturing entities, this cost might be apportioned between production and selling & administrative segments in the income statement. Meanwhile, for others, it could be directly listed under the selling & administrative section.
The method of accounting employed, such as the accrual basis, influences how rent expenses are recorded. Under the accrual method, payments made in advance are initially documented in the prepaid expenses account as assets. As time progresses or when the business occupies the rented space, these expenses are then transferred to the expense column.
The concept of deferred rent comes into play when companies receive free periods or discounts at the initiation of a lease. This necessitates the inclusion of a deferred rent asset or liability account on the balance sheet, ensuring consistent representation of the lease's overall cost across the lease term.
Furthermore, the location of the rental property holds significant importance, particularly for real estate and retail companies. Prime locations often command higher rents but may provide increased foot traffic and access to the desired consumer base, ultimately impacting a company's revenue.
In financial records, rent expense can be allocated to various sections based on the use of the rented space, be it manufacturing or administrative purposes. Understanding the cost-benefit analysis of rental expenses in prime locations becomes crucial for companies, as it directly ties into their revenue potential.
To delve deeper into related topics mentioned in the article, exploring resources on concepts like Cost of Goods Manufactured (COGM), Fixed and Variable Costs, Inflation's impact on expenses, and projecting Balance Sheet Line Items would be beneficial for anyone interested in financial analysis and accounting principles.
