At times firms make advance payments for certain goods or services before the actual usage, these types of payments are called prepaid expense. Thus prepaid expenses are treated as an asset to the business that are shown on the companyâ€™s balance sheet showing goods or services that the company will receive in future. Although prepaid expenses are thought to be assets in the beginning, yet gradually their worth is expressed in terms of benefit in the income statement. It is sure to bring something in days to come that will carry value. Students can learn more about the definition of prepaid expenses from online portals by searching topics like prepaid expenses homework answers.
Simplifying prepaid expenses
At times requirement of prepaid expenses arise due to certain features of goods or services.Like if we take the example of insurance policies, it is a prepaid expense because purchase of the policy is done presently so that it can render benefits in future in case of any mishap. An insurance company cannot take the payment of the policy after maturity, so this expense has to be prepaid in nature.
Let us go through an example, suppose a firm had a yearâ€™s insurance policy of $2,400. With passage of a month, the companyâ€™s income statement will show an expense of $200 as prepaid insurance till the account gets clear by the end of the year. Students can learn more such examples by searching online topics like prepaid expenses homework answers.
Recording prepaid expenses in journal entry
Expenses that have already been paid but their goods or services have not been received yet are the prepaid expenses. These expenses are considered to be asset to the firm. For prepaid expenses, increment in asset has to be debited and decrement in expense has to be credited. There are two accounts involved in journal entry of the prepaid expenses; they are the prepaid account of expense and the account of expense. The format for the entry is as follows â€“
Prepaid account of expense â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦ Debit
To account of expense â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦ Credit
If we consider an example where the rent of a company for the month of January, say $5000 has been paid earlier in the month of December. The required journal entry for the month of December should be â€“
Prepaid account of expense â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦ $5000
To account of expense â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦ $5000
Learners can gain knowledge about journal entries of these prepaid expenses by searching links like prepaid expenses homework answers online.
Prepaid expense adjustments
The payments in advance that a company makes for its various operations like rent, insurance etc are the prepaid expenses, thus these are considered to be the firmâ€™s assets
All expenses are identified at the time consumption irrespective of the time of payment. For prepaid expenses, the product or services are not incurred when the payment is made, thus they are not recorded as expenses instead they are termed as current assets as the products are available for use. These expenses generally o through adjustment towards the end of the financial period. The type of entry method for these expenses depends on its entry into the journal at the time of initial notification. The two different procedures for accounting prepaid expenses are as follows â€“
- Method of asset
When the method of asset is used, the account of prepaid expense that is considered an asset is noted at the time of payment, this could include insurance, rent, supplies etc.
If an example as follows is taken where a company makes a payment of $2,000 for a particular service and at the end of the month 60% of the service has been used. Then from $2,000 amount of service, $1,200 has been used and $800 is remaining. In this case, $1,200 is considered the expense that has been utilized already.
While adjusting the entry, the aim is to transfer the part utilized from the initially noted asset. The adjustment would include identifying the expense and decrement in the initially recorded asset. After the entry is made, the unused amount stands out to be $800.
- Method of expense
In this method, the full payment made is noted as expense. The entry thus is like the following-
Service expense â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦ $2,000
Cash â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦.. $2,000
In this format, if 60% is used, then debit is for $800 that is the unused part. The service expense is entered as credit, this results in decreasing the balance. The service expense is thus now at $1,200. This is a result of $2,000 as debit and $800 as credit. A proper knowledge requires practice and students can easily practice such examples by searching links like prepaid expenses homework answers online.
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