Proration is a method of assigning an amount to different periods, accounts, or beneficiaries based on their proportionate share. In finance and accounting, this concept is often used when a pool of resources needs to be divided across multiple areas. The term “prorate” comes from the Latin term “pro rata”, which means “in proportion”.
Here are a few common examples of proration:
- Expenses or Revenues: If a company pays for a one-year insurance policy upfront, that cost will be prorated over the twelve months of the policy period. Each month, one-twelfth of the cost will be recognized as an expense, while the remainder will be recorded as a prepaid expense.
- Dividends: If a shareholder owns 200 shares in a company that issues a dividend of $1,000,000, their share of the dividend will be prorated based on the proportion of shares they own out of the total shares outstanding.
- Rent: If a tenant moves into an apartment in the middle of the month, their rent might be prorated. They would pay for only the days they were actually in the apartment, rather than the full month’s rent.
- Inheritance: If a person leaves an estate to be divided among multiple heirs, the value of the estate would be prorated based on the proportion designated to each heir in the will.
In general, proration is a way to allocate amounts fairly and proportionally. It ensures that costs, revenues, or other resources are divided according to an agreed-upon factor, such as time, ownership percentage, or usage.
Example of Proration
Let’s consider a practical example involving rent proration.
Suppose a tenant is moving into a rental apartment on the 10th of May. The monthly rent for the apartment is $1,500. The landlord and tenant agree to prorate the rent for the first month because the tenant will not be occupying the apartment for the entire month.
Here’s how to calculate the prorated rent:
- Determine the daily rental rate by dividing the monthly rent by the total number of days in the month.
In this case, May has 31 days, so the daily rent would be $1,500 / 31 = $48.39 per day.
- Multiply the daily rental rate by the number of days the tenant will occupy the apartment in the first month.
Since the tenant is moving in on the 10th of May, they will occupy the apartment for 22 days (from 10th to 31st of May). So, the prorated rent for May would be $48.39 * 22 = $1,064.58.
So, instead of paying the full $1,500 for May, the tenant will pay the prorated amount of $1,064.58. This is a fairer arrangement, as the tenant is only paying for the days they will actually occupy the apartment.