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 the period of one year. As per the agreement, X Ltd has to pay the 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 the month of January 2019.
Solution
The date when the rent expense and insurance expense 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 insurance in the monthly financial statements of the company 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 entry 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
This adjusting journal entry will be passed every month by the company for the next 12 months in order 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 the month of January 2019, amounting $ 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 period ending in 2018, on December 31, 2018 salary has been paid in advance to the employees of the company 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 will actually get 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), then the journal entry should be passed to record it on the date when it is paid and 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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