Part 5.1 – Rent Charges

These example sections end up being long, so I’m going to split each section into separate blog posts.

At the end of each blog post is a diagram with all of the accounts that were used. Each transaction is labeled, in the diagram, with a # that corresponds to the example #. It is a good idea to print this diagram out, so you can follow along visually.

Examples: Rent Charges

1) Tenant Rent Charge

Level: Intro

Problem: Joe, a tenant, is charged $750 for rent.

Solution:

Debit “Accounts Receivable” by 750. (+)

Credit “Rental Income” by 750. (+)

Explanation:

  • “Accounts Receivable” represents money that is owed to us, but hasn’t been paid yet. Since we charged Joe, he owes us money. We increased the “A/R” account because an “A/R” account is like a bank account for money that hasn’t been collected yet.
  • Even though, Joe hasn’t paid; we are expecting payment, so this charge is considered income.

Cash Accounting Note:

In cash accounting, a charge has no debit/credit transactions. This is because income is not counted until payment is received.

2) Pet Fee Charge

Level: Intro

Problem: Joe is charged a $25 pet fee.

Solution:

Debit “Accounts Receivable” by 25. (+)

Credit “Pet Fee Income” by 25. (+)

Explanation:

The only difference between this example and Example 1 is that we used a different income account.

3) Standard Charge Decrease

Level: Medium

Problem: Joe comes into the office with some sob story about something or other. We’re not listening ‘cause we’re so used to tenants coming in with made-up or irrelevant sob stories… which all end in, “So, I’m going to be late on the rent,” or “I need you to give me a break on the rent this month.” While daydreaming, we accidentally agree to a $50 rent discount for this month.

Solution:

Debit “Rental Income” by 50 (-)

Credit “Accounts Receivable” by 50 (-)

Explanation:

We are reducing Joe’s charge from example 1. So, we are doing the exact opposite transactions from example 1, in the amount of 50.

 

4) Charging Tenants Their Expenses

Level: Medium + Interesting

Problem: Mike moved into one of our apartments, but the electricity didn’t get switched over to his name. We got his electricity bill for $100 and paid it. We now want to charge him the $100.

Solution: There are 2 ways of doing this:

4.1) The 1st way is to charge Mike using an income account.

Debit “Accounts Receivable” by 100 (+)

Credit “Other Income” by 100 (+)

4.2) The 2nd way is to charge mike using an expense account.

Debit “Accounts Receivable” by 100 (+)

Credit “Electricity” by 100 (-)

Explanation:

In the end, both solutions give the same result on the income statement.

  • Solution 4.1 counts the charge as $100 of income. However, the income is offset by the $100 electricity expense (not shown in the diagram: would be a debit in the “Electricity” account of 100). Therefore, our net income (profit) remains the same. It is as if we never received Mike’s electricity bill.
    • The disadvantage to this solution is that when you are later reviewing this month (or year), you will show a higher electricity usage that what actually occurred. You will also show a higher income. The 2 increases cancel each other out, but it will be tougher to review the company’s past performance and budget for the future.
  • Solution 4.2 counts the charge against an expense account. When we received the $100 electricity bill, we debited (increased) the “Electricity” account. What solution 4.2 accomplishes is a decrease in the “Electricity” account by $100, so that all account balances remain the way they should. The end result is that all accounts have the balance they should have if this electricity mishap never happened.

5) Tenant’s current balance is negative. Tenant is then charged rent.

Level: Med/Adv

Problem: Nancy has a balance of $-75 (she overpaid last month). She is charged her monthly rent of $500.

Solution:

Debit “Accounts Receivable” by 425 (+)

Debit “Prepaid Rent” (liability) by 75 (-)

Credit “Rental Income” by 500 (+)

Explanation:

  • “Accounts Receivable” represents money that we are expecting to receive. Since Nancy has a balance of $-75, we are only expecting to receive $425.
  • Nancy has the $-75 balance because she overpaid last month; so, we know that last month the “Prepaid Rent” liability account was credited (increased) by 75. Since we charged Nancy her monthly rent, she has no more prepaid balance. We, therefore, need to remove the liability from our books by debiting the “Prepaid Rent” account by the amount of Nancy’s overpayment.
  • We charged Nancy her rent and, regardless of any other variables, that charge is income. So, we need to Credit the income account.

6) Charge Decrease. Tenant currently has a positive balance. Decrease will give tenant a negative balance.

Level: Take That! (This is only tough until you read the solution. Then you’ll say, “Oh yeah, of course that’s how it’s done.”… you no idea.)

Problem: Jessica’s monthly rent is $500. On May 31, her balance was $-600. On June 1, her rent was accidentally charged twice; a total of $1,000. These charges brought her balance up to $400. By the time we realized this error, 2 months had passed and Jessica’s balance was now $300. We need to delete the $500 charge…

If your first thought is to use an eraser, then I can’t even begin to explain to you how screwed up your books will be. I just finished writing this problem and I’m rereading it… It turns out that I can begin to explain why the eraser is a bad idea. It’s explained at the end.

Solution:

Debit “Rental Income” by 500 (-)

Credit “Accounts Receivable” by 300 (-)

Credit “Prepaid Rent” by 200 (+)

Explanation:

Half of what I talked about in this problem has no bearing on what we do to the books. The only thing we care about here is the amount that we need to decrease the charge by and Jessica’s current balance. We don’t care about her balance at the time of, or after, the original charge. I will explain why we don’t care after I give the explanation for our solution.

  • We debited “Rental Income” by the full amount because that charge was an accident and we should not show any income. So, we countered the original “Rental Income” credit (+) with a “Rental Income” debit (-).
  • We credited “A/R” because Jessica has had a series of charges and payments that brought her balance to $300. I don’t care what the series of events was. All care about right now is that our “A/R” account is expecting $300 from Jessica. So, we credited (-) the “A/R” account so that there is no expectation of payment.
  • Removing the accidental charge ended up taking Jessica’s balance negative, which means that we are in debt to Jessica for $300. The debt is not an actual loan and we will repay the debt by letting Jessica use our apartment. Therefore, Jessica just has some prepaid rent and we’ll credit (+) the “Prepaid Rent” liability account to show this debt.

Here’s why we don’t care about the extra information: Taking into account the original balances would be the same as simply removing the original debits/credits from the books. This is a problem because there have been charges and payments since the accidental charge; these charges/payments had debits and credits that took into account Jessica’s balance at that time. Let’s take a closer look at what would happen if we simply removed the original charge’s debits/credits:

  • After the first correct payment, the account values, in the books, were as follows:
    • Prepaid Rent: 100
    • Accounts Receivable: 0
    • Undeposited Funds: 0
    • Rental Income: 500
    • Misc Income: 0
  • When the accidental charge happened (the 2nd of the 2 $500 charges), the transactions were as follows:

Debit “Prepaid Rent” by 100 (-)

Debit “Accounts Receivable” by 400 (+)

Credit “Rental Income” by 500 (+)

  • Jessica’s balance is now $400. Let’s say there were 2 transactions after the accidental charge, which was a misc. charge for $600 and a payment of $700. This would look like:

Charge: Debit “Accounts Receivable” by 600 (+)

Charge: Credit “Misc Income” by 600 (+)

Payment: Debit “Undeposited Funds” by 700 (+) (“Undeposited Funds” is an asset account that holds payments until deposited.)

Payment: Credit “Accounts Receivable” by 700 (-)

  • This brings Jessica’s balance to the $300 that was mentioned in the problem. The values of the accounts are now:
    • Prepaid Rent: 0
    • Accounts Receivable: 300
    • Undeposited Funds: 700
    • Rental Income: 1000
    • Misc Income: 600

This looks good. “Accounts Receivable” is telling us that Jessica owes us $300.

  • If we simply removed the accidental charge’s original debits/credits, then the values of the accounts would look like:
    • Prepaid Rent: 100
    • Accounts Receivable: -100
    • Undeposited Funds: 700
    • Rental Income: 500
    • Misc Income: 600

“Prepaid Rent” is now telling us that Jessica has a balance of $-100, but it should be telling us that Jessica’s balance is $-200. “Accounts Receivable” is telling us that there is $-100 expected from Jessica. These 2 accounts, combined, tell us of Jessica’s balance, but neither is correct… anyway, we can’t have a negative “Accounts Receivable” balance… that would just be crazy.

Simply erasing the debits/credits ended up screwing up our books. In 4 months, when we are preparing our taxes, we’ll see that there is a problem, but we probably won’t be able to locate the error.

  • We already proved that erasing debits/credits is a bad idea, but here’s how our solution added up: If we take the account values after the accidental charge and the next $600 charge and $700 payment, then apply our debits/credits from the correct solution up top; then our final account values look like this:
    • Prepaid Rent: 200
    • Accounts Receivable: 0
    • Undeposited Funds: 700
    • Rental Income: 500
    • Misc Income: 600

Well, that’s exactly how the accounts should look… problem solved!

Property Management Accounting Examples

 



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