What are Prepaid Expenses?

Prepaid costs represent expendituresExpenditureAn expenditure to represent a payment with either cash or credit to purchase goods or services. An expenditure is videotaped at a single point in that have actually not however been taped by a company as one expense, but have been paid for in advance. In various other words, prepaid expenses are expenditures paid in one audit period, however will no be known until a later accountancy period. Prepaid expenses are at first recorded together assets, since they have actually future financial benefits, and are expensed in ~ the time when the benefits space realized (the equivalent principle).

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Summary

Prepaid costs are future prices that room paid in advancement and for this reason recognized at first as one asset. As the benefits of the prices are recognized, the associated asset account is decreased and expensed. The many common types of prepaid costs are prepaid rent and also prepaid insurance.


Common reasons for Prepaid Expenses

The 2 most common uses the prepaid prices are rent and insurance.

1. Prepaid rent is rent paid in breakthrough of the rental period. The journal entries because that prepaid rent room as follows:

Initial journal entry because that prepaid rent:

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Adjusting newspaper entry as the prepaid rental expires:

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2. Prepaid insurance is insurance payment in development and that has not however expired on the date of the balance sheetBalance SheetThe balance sheet is just one of the three an essential financial statements. The financial statements are vital to both jae won modeling and also accounting..

Initial newspaper entry because that prepaid insurance:

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Adjusting newspaper entry as the prepaid insurance expires:

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Prepaid expenses Example

We will look at two instances of prepaid expenses:

Example #1

Company A signs a one-year lease on a warehouse for $10,000 a month. The landlord calls for that company A payment the yearly amount ($120,000) upfront in ~ the start of the year.

The initial newspaper entryJournal Entries GuideJournal Entries room the structure blocks the accounting, from report to auditing newspaper entries (which consists Debits and Credits) for firm A would certainly be as follows:

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At the finish of one month, company A would’ve supplied up one month of its lease agreement. Therefore, prepaid rent have to be adjusted:

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Note: One month synchronizes to $10,000 ($120,000 x 1/12) in rent.

The adjusting newspaper entry is done each month, and also at the end of the year, when the lease covenant has no future financial benefits, the prepaid rent balance would certainly be 0.

Example #2

Upon signing the one-year lease commitment for the warehouse, the company also to buy insurance for the warehouse. The firm pays $24,000 in cash upfront for a 12-month insurance plan for the warehouse.

The initial newspaper entry for agency A would be together follows:

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At the end of one month, company A would have used up one month of its insurance allowance policy. Therefore, prepaid insurance should be adjusted:

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Note: One month corresponds to $2,000 ($24,000 x 1/12) in insurance allowance policy.

The adjusting newspaper entry is done each month, and also at the finish of the year, once the insurance allowance policy has no future economic benefits, the prepaid insurance money balance would certainly be 0.

Effect of Prepaid expenses on financial Statements

The initial newspaper entry for a prepaid price does not affect a company’sfinancial statements. Because that example, describe the an initial example the prepaid rent. The initial journal entry because that prepaid rent is a debit come prepaid rent and a credit to cash.

These are both asset accounts and do not rise or diminish a company’s balance sheet. Recall that prepaid costs are taken into consideration an asset since they provide future economic benefits to the company.

The adjusting journal entry for a prepaid expense, however, does affect both a company’s revenue statement and balance sheet. Describe the very first example the prepaid rent. The adjusting entrance on January 31 would result in an cost of $10,000 (rent expense) and a to decrease in assets of $10,000 (prepaid rent).

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The cost would present up top top the revenue statement if the diminish in prepaid rental of $10,000 would alleviate the assets on the balance paper by $10,000.

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