Answered: Proper adjusting entry based on prepaid

A company’s property insurance, liability insurance, business interruption insurance, etc. often covers a one-year period with the cost (insurance premiums) paid in advance. The one-year period for the insurance rarely coincides with the company’s accounting year. Therefore, the insurance payments will likely involve more than one annual financial statement and many interim financial statements. If the prepayment covers a longer period, then classify the portion of the prepaid insurance that will not be charged to expense within one year as a long-term asset. The income statement account Insurance Expense has been increased by the $900 adjusting entry.

So, According to the GAAP (Generally Accepted Accounting Principles), you would record it in the same accounting period as the benefit generated from the related asset. As per the traditional classification of accounts, a prepaid expense is a type of personal account (representative personal). They may be tangible or intangible items used to generate economic value for business operations. An expense that is paid before it is due is considered prepaid and it is treated as an asset (current) for the business. When the actual salary is due, the amount is deducted from the prepaid salaries account and is shown as an operating expense in the current period’s Income Statement.

• If you use cash-basis accounting, you only record transactions when money physically changes hands.
• An amortization schedule that corresponds to the actual incurring of the prepaid expenses or the consumption schedule for the prepaid asset is also established.
• BlackLine Journal Entry is a full journal entry management system that integrates with BlackLine Account Reconciliations.
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Prepaid Expenses Journal Entry

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• The balance in Service Revenues will increase during the year as the account is credited whenever a sales invoice is prepared.
• The journal entry above shows how the first expense for January is recorded.
• A common prepaid expense is the six-month insurance premium that is paid in advance for insurance coverage on a company’s vehicles.
• Rather, they are classified as current assets, readily available for use when the company needs them.

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How to Record Prepaid Expenses?

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Simplifying Prepaid Expenses Adjustment Entry with an Example

As the insurance coverage is consumed over time, the prepaid insurance asset is gradually reduced, and an expense is recognized. This is done by debiting the “Insurance Expense” account and crediting the “Prepaid Insurance” asset account. The goal is to match the expense with the period in which the insurance coverage is being utilized. They are recorded in books of finance at the end of an accounting period to show the true numbers of a business. They are also known as unexpired expenses or expenses paid in advance. When you make a payment for a prepaid expense, you initially debit your prepaid expense account and a credit to the cash account (or accounts payable, if payment is made on credit).

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Prepaid expenses are first recorded in the prepaid asset account on the balance sheet as a current asset (unless the prepaid expense will not be incurred within 12 months). Once expenses incur, the prepaid asset account is reduced, and an entry is made to the expense account on the income statement. Prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract. When the asset is charged to expense, the journal entry is to debit the insurance expense account and credit the prepaid insurance account. Thus, the amount charged to expense in an accounting period is only the amount of the prepaid insurance asset ratably assigned to that period. A prepaid expense can be recorded initially as an expense or as a current asset.

At the end of the month, before the books are closed for the month, make one double entry to the journal. If the premium were $1,200 per year, you would enter a credit of $100 to the prepaid insurance asset account, decreasing its value. Then you would enter a debit to the insurance expense account, increasing the value of the expenses. When the company makes an advance payment for insurance, it can make where do dividends appear in the financial statements by debiting prepaid insurance account and crediting cash account. Also,Prepaid expenses are expenditures in one accounting period, and they you will not recogniz until a later accounting period.

Prepaid advertising refers to a type of prepaid expense where a business pays for advertising services in advance before they are rendered. This typically involves paying for advertising space or airtime for a specified period, such as a few weeks or months, before the advertising campaign begins. As the benefits of the prepaid expense are realized, it is recognized on the income statement.

They accrue when we pay for something that we will receive in the near future. They don’t provide right at instant time rather in a future course of time. Sometimes the companies pay for the expenses in advance before the expenses become due. This may be due to some discount being offered or longer subscription or validity being offered. They haven’t been recorded by the company as an expense, but have been paid in advance.

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Failing to recognize the remaining amount as an expense can result in overstating the company’s net income. BlackLine is a high-growth, SaaS business that is transforming and modernizing the way finance and accounting departments operate. Our cloud software automates critical finance and accounting processes. 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. What we are actually doing here is making sure that the incurred (used/expired) portion is treated as expense and the unused part is in assets.

At the end of the year, you will have expensed the entire $24,000, and your prepaid rent account will have a $0 balance. Hence, prepaid insurance journal entry does not affect the total assets because it increases one asset account and decreases another asset account at the same amount. The income statement for the quarter ending will, therefore, show an insurance expense of $2,500 under the line item of Insurance Expense.