Prepaid Rent on Cash Flow Statement
Prepaid Rent
Prepaid rent is the amount of cash paid to the landlord in advance. The company pays monthly rental fees in advance while they are not yet using the rental services.
When the company paid rental fees, they will be recorded as the prepaid rent on the balance sheet. Based on the accrued accounting, revenue and expenses are recorded when they really incur. It is not related to the payment date.
The prepaid rent is recorded as the current assets on the company balance sheet. At the end of each month, the accountant has to reverse the prepaid rent to rental expense based on the rental fee.
When the company pays the prepaid rent, they need to record prepaid rent and cash outflow. The journal entry is debiting prepaid rent and credit cahs paid.
| Account | Debit | Credit |
|---|---|---|
| Prepaid Rent | $$$ | |
| Cash | $$$ |
The transaction will increase the prepaid rent which is the current asset on the balance sheet. We cannot record expenses yet as we have not yet used the rental service. The company makes a prepayment, it is paid before the consumption of the rental service.
At the end of each month, it means that the company has utilized the rental service from the landlord. So they have to reverse the prepaid rent to the rental expense on the income statement.
The journal entry is debiting rental expense and credit prepaid rent.
| Account | Debit | Credit |
|---|---|---|
| Rental Expense | $$$ | |
| Prepaid Rent | $$$ |
The transaction will reduce the prepaid rent balance on the balance sheet and increase expenses on the income statement. The expense is recorded when the company consumes the rent at the end of the month. The prepaid rent is also reduced as it is utilized to settle rental expenses.
Cash Flow Statement
Cash flow statement is one of the company’s financial statements which presents the cash movement in the financial period. It shows the cash at the beginning of the period, cash inflow, cash outflow, and the remaining cash at the end of the period.
The cash flow within the company arises from three activity which includes operating, investing, and financing.
Operating activity represents the cash flow that happens due to the main business activity of the company. Cash inflow arrives from cash collected from sale revenue, cash outflow happens due to the payments related to the cost of goods sold, and other operating expenses.
Investing activity summarizes all the cash in and out which happens related to the company investment in fixed assets, financial security, and other forms of investment. The cash outflow results from the purchase of investments such as fixed assets, investment property, bonds, and share capital of other companies, and so on. The cash inflow comes from the sale of these assets.
Financing activities include all the cash paid and generate from the funding of the company. The company can raise money by issuing bonds, share capital, and loans from banks or creditors. The company has to pay cash to settle the loan, bond, and repurchase the share capital.
Prepaid Rent on the Cash Flow Statement
As we can see above journal entries related to the prepaid rent, impact the cash account only when the company paid for the prepaid rent. When the company reverses the prepaid rent, it only impacts the prepaid account and expense account.
However, both transactions have an impact on the cash flow statement. It sounds a bit confusing, we will explain the futhur below.
First, we need to understand the process of a cash flow statement being prepared. Here is a brief summary base on the indirect method.
The cash flow starts from net income and adjusts for the non-cash transactions and changes in working capital. It presents the cash flow from operating activities.
| Account | Amount |
|---|---|
| Net Income/(Loss) | $$$/($$$) |
| Non-Cash transaction: | |
| – Amortization | $$$ |
| – Depreciation | $$$ |
| Change in working capital | |
| – Increase in working capital | $$$ |
| – Decrease of working capital | ($$$) |
| Net Cash flow from Operating Activity |
The non-cash transaction includes the depreciation and amortization expense. These are the transaction that needs to add back as they are not related to cash paid. It is just the movement of fixed assets to expenses.
Net income arrives from the income statement which follows the accrued basic. So it means that all revenues are equal to cash collected, some of them will become accounts receivable on balance sheet. All expenses do not represent the cash paid, some of them become accounts payable. So we have to adjust them with working capital which includes:
- Accounts Receivable
- Inventory
- Prepaid Rent
- Prepaid Insurance
Increase in Prepaid Rent
When the company paid for the prepaid rent, the transaction will increase the balance on balance sheet. The cash flow is paid to the landlord, but it is not reflected in the income statement as we follow accrue basic. So the amount of prepaid rent needs to be reduced in the cash flow. It is the decrease in working capital.
It will impact cash flow as follows:
| Account | Amount |
|---|---|
| Net Income/(Loss) | $$$ |
| Non-Cash transaction: | |
| – Amortization | |
| – Depreciation | |
| Change in working capital | |
| – Increase prepaid rent | ($$$) |
| – Decrease of working capital | |
| Net Cash flow from Operating Activity |
Decrease of Prepaid Rent
On the other hand, when the company reverses the prepaid rent and records a rental expense, it will reflect on the income statement. But actually, there is no cash paid at all. So we have to add back the amount that decreases from the balance sheet.
We have to increase cash inflow to add up with the decrease in net income in the income statement.
| Account | Amount |
|---|---|
| Net Income/(Loss) | $$$ |
| Non-Cash transaction: | |
| – Amortization | |
| – Depreciation | |
| Change in working capital | |
| – Decrease prepaid rent | $$$ |
| – Decrease of working capital | |
| Net Cash flow from Operating Activity |
