This method initially records the advance payment as an expense by making the following journal entry: Expense Method Entry at the Time of Cash Payment The journal entry at the time of payment shows: Adjusting EntryĪn expired portion of prepaid expense increases the expense and decreases the asset by making the following adjusting entry at the end of the accounting period: 2. The payment of expense in advance increases one asset (prepaid or unexpired expense) and decreases another asset ( cash). This method sees an expense paid in advance recorded as an asset. Asset Method Entry at the Time of Cash Payment The accounting process under both methods is explained below. Prepaid or unexpired expenses can be recorded under two methods - asset method and expense method. When preparing the balance sheet, prepaid insurance, $3,200, will be shown as a current assetĪccounting Process for Prepaid or Unexpired Expenses.When preparing the profit and loss account, insurance expenses will amount to $1,600 ($4,800 less $3,200).The above journal entry would have two effects: John's case, the journal entry would show: The Relevant Expenses Account With the amount that relates to the coming year Prepaid Expense A/c (a newly opened account) The following journal entry accommodates a prepaid expense: John's favor of an amount equal to the value of unused, or unexpired, insurance The correct insurance expense for the year is less than the amount indicated by the trial balance.John's trial balance on 31 December 2019 will, therefore, require adjusting to show that: Thus, what has been paid for remains an asset unless it is fully used. John's trial balance does not disclose it, there is a current asset of $3,200 on 31 December 2019. The balance, $3,200 (4,800 - 1,600), relates to 2020 and should be charged to that year's profit and loss account.Īlthough Mr. The correct insurance expenses for 2019 comprise 4/12th of $4,800 = $1,600. It would be incorrect to charge the whole $4,800 to 2019's profit and loss account. The premium covers twelve months from 1 September 2019 to 31 August 2020, i.e., four months of 2019 and eight months of 2020. However, only a part of this amount relates to 2019. The trial balance, drawn up on 31 December 2019, assumed that he had no other insurance and his insurance expenses account would show a balance of $4,800. When he paid this premium, he debited his insurance expenses account with the full amount, i.e., $4,800. John bought a motor car and got it insured for one year, paying $4,800 as a premium. Prepaid Expenses: ExplanationĪt the end of the year, there may be expenses whose benefits have been received but not paid for and expenses that may have been paid, but their benefit will appear in the next financial year. The first portion, comprising received benefits, is an expense.Īs for the second portion, which involves the incoming benefits or services used in the coming period, this represents current assets, otherwise known as unexpired expenses, prepaid expenses, or expenses paid in advance.Īt the end of the accounting period involving advance payment, the expired portion becomes part of the income statement like any other expense the unexpired portion becomes part of the balance sheet like any other current asset. Unexpired or prepaid expenses are the expenses for which payments have been made, but full benefits or services have yet to be received during that period.
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