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For example, a company pays $12,000 in advance for Internet advertising that will extend through a full year. An accrued revenue is the revenue that has been earned (goods or services have been delivered), while the cash has neither been received nor recorded. The revenue is recognized through an accrued revenue account and a receivable account.

To recognize prepaid expenses that become actual expenses, use adjusting entries. Create a prepaid expenses journal entry in your books at the time of purchase, before using the good or service. The process of recording prepaid expenses only takes place in accrual accounting. If you use cash-basis accounting, you only record transactions when money physically changes hands.

Introduction to Adjusting Journal Entries

The $25,000 balance in Equipment is accurate, so no entry is needed in this account. As an asset account, the debit balance of $25,000 will carry over to the next accounting year. Of the total six-month insurance amounting to $6,000 ($1,000 per month), the insurance for 4 months has already expired. In the entry above, we are actually transferring $4,000 from the asset to the expense account (i.e., from Prepaid Insurance to Insurance Expense). A prepaid expense by definition is an expense that has been paid for by the business in advance, that is, before the services for that expense have been availed. In this case, the business must record such expenses as prepaid expenses.

Prepaid expenses represent expenditures that have not yet been recorded by a company as an expense, but have been paid for in advance. In other words, prepaid expenses are expenditures paid in one accounting period, but will not be recognized until a later accounting period. Prepaid expenses are initially recorded inventory ins and outs as assets, because they have future economic benefits, and are expensed at the time when the benefits are realized (the matching principle). Regardless of whether it’s insurance, rent, utilities, or any other expense that’s paid in advance, it should be recorded in the appropriate prepaid asset account.

On June 1st, 2020, you will make the following journal entry to reflect this advance payment for insurance. In the business, the company usually needs to make an advance payment for the insurance that it has purchases. In this case, it is important for the company to record the payment as prepaid insurance.

The income statement account that is pertinent to this adjusting entry and which will be debited for $1,500 is Depreciation Expense – Equipment. When the asset is charged to expense, the journal entry is to debit the insurance expense account and credit the prepaid insurance account. A prepaid expense is a type of asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. Prepaid expenses are initially recorded as assets, but their value is expensed over time onto the income statement. Expenses that are used to make payments for goods or services that will be received in the future are known as prepaid expenses. But, as the benefit of the prepaid expense is realized, or as the expense is incurred, it is recognized on the income statement.

How to Create a Prepaid Expenses Journal Entry

This change is automatic and does not require permission from the IRS in advance. Now, that we understand this, what journal entries will one make to record the $100 worth of insurance used and the $1,100 worth of prepaid insurance remaining? To answer this, let’s discuss the journal entry for prepaid insurance.

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It is only after this that the adjusting entry for the month, quarter, or year can be made. Prepaid expenses are expenses that we have taken into account in the current period, but we plan to receive the benefit in this regard in the future. In other words, you spent money today in order to get goods, services, or other benefits tomorrow.

Adjusting Journal Entries and Accrual Accounting

From the perspective of the buyer, a prepayment is recorded as a debit to the prepaid expenses account and a credit to the cash account. When the prepaid item is eventually consumed, a relevant expense account is debited and the prepaid expenses account is credited. The adjusting journal entry for a prepaid expense, however, does affect both a company’s income statement and balance sheet. The adjusting entry on January 31 would result in an expense of $10,000 (rent expense) and a decrease in assets of $10,000 (prepaid rent). Therefore the account Accumulated Depreciation – Equipment will need to have an ending balance of $9,000.

Assume ABC company buys one-year insurance for its truck and pays $1200 for this insurance on December 1, 2022. In the company’s book, this prepaid insurance will be classified as an asset. In this case, it will be classified as a current asset on the Balance Sheet because it covers and falls within one year. Notice that the ending balance in the asset Supplies is now $725—the correct amount of supplies that the company actually has on hand.

The insurance expense account increases by the debit entry while the prepaid insurance account decreases by the credit entry. However, if the advance payment covers a longer period, then the portion of the unexpired prepaid insurance that has not been charged to expense within one year will be reported as a long-term asset. In order to understand how prepaid insurance works, let’s take an example.

Supplies Expense will start the next accounting year with a zero balance. The balance in the asset Supplies at the end of the accounting year will carry over to the next accounting year. Prepaid insurance is the portion of an insurance premium that has been paid in advance and has not expired as of the date of a company’s balance sheet. This unexpired cost is reported in the current asset account Prepaid Insurance.

Record prepaid insurance with journal entry

A review indicates that as of December 31 the accumulated amount of depreciation should be $9,000. A prepaid expense can be recorded initially as an expense or as a current asset. The current month’s insurance expense of $1,000 ($6,000/6 months) is reported on each month’s income statement. The unexpired amount of the prepaid insurance is reported on the balance sheet as of the last day of each month. This is usually done at the end of each accounting period through an adjusting entry.

The income statement account Supplies Expense has been increased by the $375 adjusting entry. It is assumed that the decrease in the supplies on hand means that the supplies have been used during the current accounting period. The balance in Supplies Expense will increase during the year as the account is debited.

There are also many non-cash items in accrual accounting for which the value cannot be precisely determined by the cash earned or paid, and estimates need to be made. The entries for these estimates are also adjusting entries, i.e., impairment of non-current assets, depreciation expense and allowance for doubtful accounts. Prepaid insurance is adjusted from time to time to account for the gradual expiration of the insurance premium that had been previously prepaid for by a company. These adjusting entries are necessary because they have a direct impact on the company’s financial statements which get issued either monthly, quarterly, or yearly.

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