Deferred rent for ASC 840 and ASC 842 explained

What is deferred rent under ASC 840 and ASC 842?

Deferred rent is the gap between the rent you pay and the rent expense you record on a straight-line basis over the lease term.

• Under ASC 840, deferred rent sat as its own line on the balance sheet.
• Under ASC 842, it folds into the lease liability and right-of-use asset.
• Tracking it keeps your financial reports accurate and compliant.

Leasing assets is a common practice for businesses. However, the accounting for these leases can get complex. One key part of lease accounting is knowing how to record deferred rent.

In 2019, new rules arrived under ASC 842. As a result, they changed how businesses record and account for lease liabilities. This guide explains deferred rent and how it differs under ASC 840 and ASC 842. It also shows why deferred rent matters and how to account for it. For a wider primer, see this overview of lease accounting.

What is deferred rent?

Deferred rent is the difference between two amounts. First, there is the rent you pay during the lease term. Next, there is the rent expense you record in the financial statements. This gap appears when the accounting records’ straight-line rent expense differs from the rent paid to the landlord.

For example, a company leases a property for $120,000 per year. It pays the full amount in year one of the lease. The straight-line rent expense would be recorded as $100,000 ($120,000/12 months). So the $20,000 difference is deferred rent. It shows up as an asset or liability on the balance sheet.

Deferred rent under ASC 840 vs. ASC 842

Under the old standard, ASC 840, deferred rent was a separate item on the balance sheet. It was the gap between the straight-line rent expense and the actual rent payments made.

However, ASC 842 changed this. Now leases sit on the balance sheet as a right-of-use (ROU) asset and a lease liability. As a result, the way you calculate and record deferred rent has changed.

Under ASC 842, deferred rent equals the difference between the recorded rent expense and the cash payments made in the period. Unlike ASC 840, ASC 842 does not use the straight-line method to find it.

Deferred rent under ASC 840 example

Say a tenant gets free rent for a set period as an incentive. The expense spreads over the lease term. So it is not recognized all at once. For example, a tenant signs a 12-month lease with three months of free rent. In that case, the monthly rent expense spreads over the full 15-month period.

Deferred rent under ASC 842 example

Here is an ASC 842 example. It applies when rent rises over the lease term. So you bill the average rent expense and the share of the deferred rent liability each period.

How ASC 842’s changes impact deferred rent

The biggest change from ASC 842 is how leases sit on the balance sheet. Before, operating leases showed up only in the footnotes. Only capital leases were recorded.

Now, ASC 842 records operating leases as ROU assets and lease liabilities. Because of this, the way you calculate and record deferred rent shifts. It now uses the new lease accounting method.

There is another key change. Deferred rent is now part of the lease liability. Before, it was a separate, standalone liability or asset. To keep books clean under these rules, some firms turn to offshore accounting teams.

Why is deferred rent important?

Deferred rent matters because it affects the financial statements of landlords and tenants. First, it keeps financial reporting accurate and compliant. By recording it, companies show a fuller picture of their lease obligations and expenses.

Deferred rent also shapes key financial metrics and ratios. For example, it affects EBITDA and operating income. So proper tracking helps stakeholders make informed decisions. It also plays a role in lease talks and portfolio reviews.

By studying the deferred rent amount, firms can gauge how lease terms hit their financials. As a result, they can make strategic decisions about renewals, expansions, or exits. It helps to know the difference between bookkeeping and accounting when you handle these entries.

Accounting for deferred rent

Companies follow a few steps to account for deferred rent under ASC 842. These steps keep recognition and reporting accurate in the lease agreement. Here is a list of the steps for deferred rent accounting:

• Identify lease contracts: First, list all lease contracts the company holds. This includes leases for real estate, equipment, or other assets.
• Determine the lease classification: Next, assess each lease as an operating or finance lease. This classification affects how you treat deferred rent.
• Record lease liabilities: For operating leases, record a lease liability at the present value of future payments. This liability includes the deferred rent portion.
• Recognize ROU assets: At the same time, record an ROU asset. It stands for the right to use the leased asset over the term.
• Pay off lease liability and ROU assets: Then reduce the lease liability and ROU asset over the term. You record the lease expense along with the deferred rent part.
• Disclose supplementary information: Finally, disclose extra details about your leases. This includes the deferred rent recognized and any key lease terms.

Many finance teams find these steps easier to manage with outside help. For firms that want scale and accuracy, accounting outsourcing in the Philippines is a popular route.

Frequently asked questions

Is deferred rent an asset or a liability?

It can be either. When paid rent is higher than recorded expense, it is an asset. When recorded expense is higher than paid rent, it is a liability.

Does deferred rent still exist under ASC 842?

Yes, but it changed form. Under ASC 842, deferred rent folds into the lease liability and ROU asset. It is no longer a standalone line.

How is deferred rent calculated under ASC 842?

It equals the difference between the recorded rent expense and the cash paid in the period. Unlike ASC 840, it does not use the straight-line method.

Why does deferred rent matter for financial reports?

It keeps reporting accurate and compliant. It also affects metrics like EBITDA and operating income, which guide investor decisions.

Key takeaways

• Deferred rent is the gap between rent paid and rent expense recorded.
• ASC 840 kept it as a separate balance sheet item.
• ASC 842 folds it into the lease liability and ROU asset.
• Tracking deferred rent keeps reports accurate and affects key ratios.
• Follow the six steps above to account for it under ASC 842.