Journal Entry for Prepaid Expenses
The following different prepaid expenses journal entries give an understanding of the most common type of situations of how prepaid expense is recorded and accounted for. As there are situations where the Journal Entry for Prepaid expense can be passed, it is not possible to provide all the types of situations.
How to Record Prepaid Expenses?
Example #1
Company X Ltd. started a business, and for that, it requires the property on rent. It signed an agreement with Mr. Y to take the property on rent for one year. As per the agreement, X Ltd has to pay rent of full 12 months in advance (at the beginning of the year on 01.01.2019) itself to the landlord amounting to $ 60,000 for a whole year.
Also, after taking the property on rent and paying the amount of rent as an advance for one whole year, it took the insurance of the property for which it paid $ 12,000 upfront for the insurance policy of the 12 months to the insurance company on 01.01.2019. Analyze the treatment of the amount paid as rent and insurance for the property by the company and pass the necessary journal entries recording the payment and the adjusting entries for January 2019.
Solution
The date when the rent expense and insurance expenseInsurance ExpenseInsurance Expense, also called Insurance Premium, is the amount a Company pays to obtain an insurance contract for covering their risk from any unexpected catastrophe. You can calculate it as a fixed percentage of the sum insured & it is paid at a daily pre-specified period. read more is paid for the whole year: January 01, 2019.
In the present case, the company X ltd. paid the full rent and insurance amount of the 12 months at one time in the beginning. So, the X ltd will recognize the $ 60,000 rent expense and the $12,000 insurance expense as the prepaid insurancePrepaid InsurancePrepaid Insurance is the unexpired amount of insurance premium paid by the company in an accounting period. This portion of unexpired insurance is an asset and will be shown in the balance sheet of the company.read more in the monthly financial statements of the companyFinancial Statements Of The CompanyFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more because the amount is paid in advance benefit of which is not yet received and the same is to be received in the future date.
The company will initially record the amount paid as the prepaid expense at the time of payment of money and adjust it subsequently every month for the next 12 months as its expense once the amount gets due. Following are the accounting entryAccounting EntryAccounting Entry is a summary of all the business transactions in the accounting books, including the debit & credit entry. It has 3 major types, i.e., Transaction Entry, Adjusting Entry, & Closing Entry. read more for recording rent and insurance expense in the monthly financial statements for the year 2019:
Entry to record the payment of rent and Insurance amount in advance
Calculation of Expenses to be recognized monthly in the financial statements
The company will pass this adjusting journal entryAdjusting Journal EntryAdjusting Entries in Journal is a journal entry made by a company at the end of any accounting period on the basis of the accrual concept of accounting. Companies are required to adjust the balances of their various ledger accounts at the end of the accounting period in order to meet the requirements of the various authorities' standards.read more every month for the next 12 months to prepare and present the correct monthly financial statement of the company, after which the balance of prepaid rent and insurance account will become nil.
Example #2
On December 31, 2018, Company Y Ltd paid the salaries for January 2019, amounting to $ 10,000 in advance to the employees of the company. Analyze the treatment of the amount paid as an advance salary by the company to its employees and pass the necessary journal entries recording the payment and the adjusting entries.
Solution
At the accounting periodThe Accounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance.read more ending in 2018, on December 31, 2018, the salary has been paid in advance to the employees, which will get due in the next month. So in the present case, the company Y Ltd. paid the expense in one accounting year (ending on December 31, 2018), which will get due in the next accounting year (ending on December 31, 2019). The company has to recognize the payment as the prepaid expense in the accounting year in which it is actually paid and adjust the same when the expense actually gets due. The following are the necessary journal entries to record the transactions
Conclusion
Prepaid expenses are the amount of the expenses of which has been paid in advance by one person to another, but the benefit of the same is not yet received. The benefits of such expenses are to be utilized by the person on the future date. Once the amount has been paid for the expenses in advance (prepaid), a journal entry should be passed to record it on the date when it is paid. The date when the benefits have been received against it, then the entry should be passed to record it as actual expense in the books of accounts.
The adjusting journal entry should be passed at the end of every period in order to prepare and present the correct monthly financial statement of the company to the stakeholders.
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