To illustrate the concept, let's assume that a company pays $3,000 on December 30 to rent a warehouse for the upcoming three-month period of January 1 through March 31. Since none of the $3,000 expires or is used up in December, none of the amount should be reported as rent expense on the income statement for the month of December. Hence the $3,000 is deferred to a balance sheet account such as Prepaid Rent (or Prepaid Expenses), which is a current asset account.
During the three months of January 1 through March 31 (when the prepaid rent is expiring) the $3,000 prepayment must be moved from the balance sheet asset account to an income statement expense account. The usual allocation will involve an adjusting entry to debit Rent Expense for $1,000 and credit Prepaid Rent for $1,000 on January 31, February 28 and March 31.
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