Is Rent Expense a Permanent Account?
Discover why rent expense is a temporary account that resets each period, unlike permanent balance sheet accounts that carry forward a balance.
Accounting classifies financial data into different accounts, which determines how transactions affect a company’s financial statements. This distinction is important for handling costs like rent, as an account’s nature dictates if its balance carries over or resets each period.
Understanding Permanent and Temporary Accounts
Permanent accounts, like assets and liabilities on the balance sheet, have cumulative balances that carry forward to the next accounting period. For example, the ending cash balance of one year is the starting balance for the next. In contrast, temporary accounts, such as revenues and expenses on the income statement, track performance for a specific period. Their balances are reset to zero at the end of the period through a process called closing.
Classifying Rent Expense
Rent expense is a temporary account because it represents the cost of using a property for a finite period. This treatment aligns with the matching principle, which requires an expense to be reported in the same period as the revenues it helped generate. Because rent expense measures a cost for a specific duration, its balance must be zeroed out at the end of the period. Carrying the balance over would misrepresent a company’s profitability in future periods.
The Accounting Cycle for Rent Expense
At the end of an accounting period, temporary accounts like Rent Expense are closed. This process involves transferring expense balances to a clearing account called Income Summary. For rent expense, the closing entry is a credit to the Rent Expense account and a debit to the Income Summary account, which reduces the rent expense balance to zero. The net balance of the Income Summary, representing the period’s net income or loss, is then transferred to a permanent equity account like Retained Earnings.
Distinguishing Rent Expense from Prepaid Rent
Confusion often arises with prepaid rent, which is different from rent expense. Prepaid Rent is an asset on the balance sheet, making it a permanent account. It is used when a company pays for rent in advance, creating an asset for a resource it has not yet consumed.
As the company uses the rent, an adjusting entry moves a portion of the Prepaid Rent asset to the Rent Expense account. For instance, if a company paid $3,000 for three months of rent, it would initially record the full amount as Prepaid Rent. Each month, it would then debit Rent Expense for $1,000 and credit Prepaid Rent for $1,000.