Adjusting Entry for Prepaid Expense

The point is that a business has to select payment options that are reasonable and appropriate for their situations and circumstances and require payments in reasonable increments. What is suitable for one type of business may not work for another. During the month you will use some of these taxes, but you will wait until the end of the month to account for what has expired.

Adjusting journal entries are used to (you guessed it) adjust the balances in certain accounts due to the passage of time. Companies must track the expiration date of prepaid expenses to ensure that they are recognized as expenses when they expire. Failing to track the expiration date can result in overstating the company’s assets and understating its expenses. When amortizing prepaid expenses, companies must recognize the remaining amount as an expense on the income statement. Failing to recognize the remaining amount as an expense can result in overstating the company’s net income.

Recording Prepaid Expenses

The balance in the current asset account Prepaid Expenses should be adjusted prior to a company issuing its financial statements. These include commercial property cover, product liability cover and employee cover. Here are some common types of insurance that are recommended for a business depending on the type of business they operate. Company premium suspense meaning A signs a prepaid insurance journal entry one-year lease on a warehouse for $10,000 a month. The landlord requires that Company A pays the annual amount ($120,000) upfront at the beginning of the year. Instead of recording every transaction individually, businesses can summarize multiple transactions into a single journal entry.

• Similarly, a prepaid insurance expense is a prepaid expense that has been paid for by the company.
• It is a contra asset account that reduces the value of the receivables.
• The adjusting entry above is made at the end of each month for 60 months.
• The adjusting entry ensures that the amount of taxes expired appears as a business expense on the income statement, not as an asset on the balance sheet.
• These payments are recorded as assets on the balance sheet until they are used or consumed, at which point they become expenses on the income statement.

In this case, assume that the equipment depreciates at a rate of $100 per month, which is determined by dividing its cost of $6,000 by 60 months (five years). It has lost $100 of its initial value, so it is now worth only $5,900. For deferred revenue, the cash received is usually reported with an unearned revenue account. Unearned revenue is a liability created to record the goods or services owed to customers. When the goods or services are actually delivered at a later time, the revenue is recognized and the liability account can be removed.

What is the Journal Entry for Prepaid Expenses?

A business license is a right to do business in a particular jurisdiction and is considered a tax. During the month you will use some of this rent, but you will wait until the end of the month to account for what has expired. During the month you will use some of this insurance, but you will wait until the end of the month to account for what has expired.

Introduction to Adjusting Journal Entries

You prepaid a one-year rent policy during the month and initially recorded it as an asset because it would last for more than one month. By the end of the month some of the prepaid rent expired, so you reduced the value of this asset to reflect what you actually had on hand at the end of the month ($11,000). To transfer what expired, Rent Expense was debited for the amount used and Prepaid Rent was credited to reduce the asset by the same amount.

Example – Journal Entry for Prepaid Insurance

The entry is mapped to the respective accounts, which are debited and credited accordingly. Want to learn more about the different types of accounts that come in useful for today’s small business? That’s a fair assumption, but as we mentioned, expenses are not recognized when you pay for them, but when they get used.

3: Adjusting Entries

These are the five adjusting entries for deferred expenses we will cover. Accruals refer to payments or expenses on credit that are still owed, while deferrals refer to prepayments where the products have not yet been delivered. In contrast to accruals, deferrals are cash prepayments that are made prior to the actual consumption or sale of goods and services.

Prepaid expenses are initially recorded as assets, because they have future economic benefits, and are expensed at the time when the benefits are realized (the matching principle). However, if in case the company pays for more than a year, then the prepaid expense will no longer be a part of the current asset. Regardless, the company must make adjusting entries to record insurance expense matched to each month and transfer it from prepaid insurance to insurance expense account. The company must continue to make appropriate journal entries to apportion the prepaid insurance expense according to the time period during which the expense will continue to accrue.