During lease entry, Deferred/Prepaid rent is the field where you enter your accrued deferred/prepaid balance from your ASC 840 or Legacy rent schedule.
What is deferred rent?
Deferred rent is a liability resulting from the difference between actual cash paid and the straight-line expense recorded on the lessee’s financial statements for an operating lease. This was an account specifically used under ASC 840 lease accounting. Under ASC 840, total rent expense is required to be recognized on a straight-line basis over the lease term even if rent payments vary.
The lessee records rent expense on a straight-line basis and captures any difference between the cash paid and the expense recognized by debiting and crediting deferred rent. Most often deferred rent is a liability that increases over the first part of the lease term as payments start low and gradually increase. and decreases to zero by the end of the lease term.
At the end of the lease, the total cash paid and the total expense recognized will be the same, and therefore the cumulative balance in the deferred rent account for each individual lease will always equal zero.
Treatment of deferred rent during transition to ASC 842
The comparison of the treatment of deferred rent under each lease accounting standard may trigger the question – if deferred rent does not exist under ASC 842, what happens to the accumulated balance of deferred rent for an operating lease during the transition from ASC 840 to ASC 842?
The new lease accounting guidance explicitly states that following the commencement of an operating lease, the ROU asset will be adjusted for several items, including any prepaid or accrued lease payments. Deferred rent, depending on whether it is a cumulative positive or negative amount, is either accrued rent or prepaid rent.
Deferred rent is most often a liability, or negative balance, representing accrued rent expense – the total rent expense recognized is more than all of the cash payments made through that specific point in time. The excess expense recorded over the total cash paid has been accrued or deferred until the cash payments are larger than the expense recognized and the accumulated liability is depleted to zero.
At transition, the accumulated deferred rent, or accrued rent, for an operating lease is an adjustment to the ROU asset related to the lease. The journal entry to record for transition is a debit (or credit) to the deferred rent account for the total amount of deferred rent related to the operating lease and a credit (or debit) to the ROU asset established for the same operating lease. With this journal entry, the accumulated deferred rent is removed from a standalone account to become part of the new ROU asset.
For more details and examples, please check out this blog.
Why does my transition month's journal entry have Deferred/Prepaid Rent?
The Journal Entry for the transition month will show Deferred/Prepaid Rent because the transition JE is designed to write off any existing ASC 840 accounts, as you transition to ASC 842.