Signing an 18-month lease on a two-bedroom townhouse with a monthly rent of \$900 creates a:

• A. future obligation (commitment) that is not recorded as a liability at signing
• B. revenue recognition for the landlord at the time of signing
• C. current liability for the total lease amount on the balance sheet
• D. prepaid rent asset for the entire lease term

Answer: (A)

Verified step by step guidance

1. Understand the nature of the lease agreement: Signing an 18-month lease creates a contractual obligation for the tenant to pay rent monthly. However, this obligation is not recorded as a liability at the time of signing because it represents a future commitment rather than a current liability.
2. Analyze the concept of liability: A liability is recorded on the balance sheet when there is a present obligation resulting from past events that will require an outflow of resources. At the time of signing, the tenant has not yet incurred the obligation to pay the rent for future months, so it is not recorded as a liability.
3. Consider revenue recognition for the landlord: Revenue is recognized when it is earned and realizable. For the landlord, revenue is recognized monthly as rent is earned, not at the time of signing the lease agreement.
4. Evaluate prepaid rent: Prepaid rent is recorded as an asset when payment is made in advance for future rental periods. At the time of signing, no payment has been made for the entire lease term, so a prepaid rent asset is not recorded.
5. Conclude the correct classification: The lease agreement creates a future obligation (commitment) for the tenant to pay rent monthly, but this obligation is not recorded as a liability at the time of signing. It is simply a contractual commitment.