Describe the appropriate adjusting entry for prepaid expenses and for deferred revenues What is the effect on net income, assets, liabilities, and stockholders’ equity of not recording a required adjusting entry for prepayments?

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• Adjusting entries for prepayments are necessary to account for cash that has been received prior to delivery of goods or completion of services.
• As the prepaid expense is consumed, the amount recognised as an asset on the balance sheet decreases and the amount recognised as an expense on the income statement increases.
• These adjustments typically occur at the end of each accounting period, and are akin to temporarily cutting off the flow through the business pipeline to take a measurement of what is in the pipeline.
• This states that revenue and related expenses must be recorded in the same accounting period when the transaction occurs, regardless of when money actually changes hands.
• Repeat the process each month until the rent is used and the asset account is empty.

Interest paid in advance may arise as a company makes a payment ahead of the due date. Meanwhile, some companies pay taxes before they are due, such as an estimated tax payment based on what might come due in the future. Other less common prepaid expenses might include equipment rental or utilities. Prepaid expenses are considered assets for a business because they represent future economic benefits.

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The adjusting entry on January 31 would result in an expense of $10,000 (rent expense) and a decrease in assets of $10,000 (prepaid rent). Prepaid insurance refers to the payment made for insurance in advance. It is an expense that has not yet been recorded as an expense because it has not expired yet. This means that the payment for prepaid insurance is made in a different accounting period from the accounting period when it will be used.

• Prepaid insurance is adjusted from time to time to account for the gradual expiration of the insurance premium that had been previously prepaid for by a company.
• The « Service Supplies Expense » is an expense account while « Service Supplies » is an asset.
• The full value of the prepaid expense is recorded as a debit to the asset account and as a credit to the cash account.
• Therefore, the $100,000 cost must be spread over the asset’s five-year life.

For example, a company pays $12,000 in advance for Internet advertising that will extend through a full year. The company initially charges the entire amount to the prepaid expenses account, and then charges $1,000 of it to the advertising expense account in each subsequent month, to reflect its usage of the expenditure. At the end of an accounting period, you must make an adjusting entry in your general journal to record depreciation expenses for the period.

Prepaid Expenses: Explanation

This means that a portion of the prepaid expense is recorded as an expense on the income statement each accounting period until the full amount of the prepaid asset has been consumed. Prepaid expenses are recorded as current assets in a company’s balance sheet when a payment is made. For example, let’s say a journal entry is recorded as amount X paid for ABC Prepaid Expense; amount X is the cash credit. By treating prepaid expenses as assets, businesses can accurately reflect the value of future economic benefits on their balance sheet.

We empower companies of all sizes across all industries to improve the integrity of their financial reporting, achieve efficiencies and enhance real-time visibility into their operations. Adjusting Entry For Prepaid Expense As the payment is a transaction between two asset accounts, there’s no cash outflow in the accounts. Hence, till the expenses are debited, the money is available with the company.

Why is prepaid insurance adjusted?

Employees are often paid for work up to a Friday (last day of the work week – for many). Accrued expenses are expenses that have been incurred but not yet paid or recorded. For example, a utility bill received at the end of the accounting period is likely not payable for 2–3 weeks. Utilities for the period have been used but have not yet been paid or recorded. Refer to the trial balance above which shows an unadjusted balance in prepaid insurance of $2,400.

• Accrued expenses are expenses that have been incurred but not yet paid or recorded.
• The initial journal entry for a prepaid expense does not affect a company’s financial statements.
• If depreciation adjustments are not recorded, assets on the balance sheet would be overstated.
• Accrued expenses have not yet been paid for, so they are recorded in a payable account.
• For the next 12 months, you will need to record $1,000 in rent expenses and reduce your prepaid rent account accordingly.
• Therefore, an adjusting entry must be recorded as of December 31 to credit Prepaid Expenses for $1,000 and to debit Insurance Expense for $1,000.

Expenses for interest, taxes, rent, and salaries are commonly accrued for reporting purposes. Each of the five steps of adjusting entries either debits an expense or credits a revenue. They are an advance payment for the business and therefore treated as an asset. The accounting rule applied is to debit the increase in assets” and “credit the decrease in expense” (modern rules of accounting). If your business is a corporation, and your corporation has declared a dividend payable to shareholders, the declared dividend needs to be recorded on the books. Assuming the dividend will not be paid until after year-end, an adjusting entry needs to be made in the general journal.

Journal Entry for Prepaid Expenses

If your business typically receives payments from customers in advance, you will have to defer the revenue until it’s earned. One of your customers pays you $3,000 in advance for six months of services. Any time that you perform a service and have not been able to invoice your customer, you will need to record the amount of the revenue earned as accrued revenue. He bills his clients for a month of services at the beginning of the following month. If you don’t, your financial statements will reflect an abnormally high rental expense in January, followed by no rental expenses at all for the following months. Justin will want to accrue the revenue earned in those months before he is able to bill his clients, otherwise his expenses will appear quite high on his income statement, while his revenue will be artificially low.

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Are Prepaid Expenses Debits or Credits?

In order to create accurate financial statements, you must create adjusting entries for your expense, revenue, and depreciation accounts. An amortization schedule is a schedule that shows the periodic amortized payments for a prepaid expense and the corresponding reduction in value of the asset until its total value reaches zero. Because of how certain goods and services are sold, most companies will have one or more prepaid expenses. For example, the purpose of insurance is to buy proactive protection for the future.

A business may pay for six months or a year of coverage in advance to receive a discount on the premium. A prepaid expense is an expense that is paid for in advance and usually in a lump sum. Items such as insurance and rent can be paid for with one payment that covers the cost of the expense for several months or a year.