How to calculate straight-line rent
/What is Rent Expense?
Rent expense is the cost incurred by a business to use an asset that it does not own. The concept usually refers to the use of office, warehouse, or factory space. It may also refer to the use of more expensive equipment items, such as vehicles or office equipment. Businesses typically rent assets either because they do not have sufficient cash to make an outright asset purchase, or because they only want to use an asset for a short period of time.
What is Straight-Line Rent?
Straight-line rent is the concept that the total liability under a rental arrangement should be charged to expense on an even periodic basis over the term of the contract. The concept is similar to straight-line depreciation, where the cost of an asset is charged to expense on an even basis over the useful life of the asset. The straight-line concept is based on the idea that the usage of the rental arrangement is on a consistent basis over time; that is, the rented asset is used at about the same rate from month to month.
How to Calculate Straight-Line Rent
To calculate straight-line rent, aggregate the total cost of all rent payments, and divide by the total contract term. The result is the amount to be charged to expense in each month of the contract. This calculation should include all discounts from the normal rent, as well as extra charges that can reasonably be expected to be incurred over the life of the arrangement.
The calculation of straight-line rent may result in a monthly rent expense that differs from the actual amount billed by the owner. This is usually because the owner has built escalating rent payments into the contract. In such a case, the straight-line amount charged to expense is higher than the actual amount billed during the first few months of the contract, and lower than the amount billed during its final months.
How to Account for Straight-Line Rent
This initial disparity, where the amount of the rent expense is greater than the amount paid, is charged to a deferred liability account. The latter disparity, where the amount paid is greater than the amount of the expense, is a reversal of the deferred liability account. By the end of the contract, the deferred liability account will have a zero balance.
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Example of Straight-Line Rent
As an example of straight-line rent, a company enters into a short-term facility rental arrangement where the amount billed is $500 per month for the first six months and $600 per month for the last six months. On a straight-line basis, the amount of rent is $550 per month. In the first month of the arrangement, the renting party would record a rent expense of $550 (debit), a cash reduction of $500 (credit), and a deferred liability of $50 (credit).