What are Prepaid Expenses?

Prepaid expenses represent expendituresExpenditureAn expenditure represents a payment with either cash or credit to purchase items or services. An expenditure is taped at a solitary point in that have actually not yet been recorded by a agency as an expense, however have to be paid because that in advance. In various other words, prepaid costs are expenditures paid in one bookkeeping period, however will no be well-known until a later accountancy period. Prepaid expenses are originally recorded together assets, because they have future economic benefits, and are expensed in ~ the time once the benefits room realized (the corresponding principle).

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Summary

Prepaid costs are future expenses that are paid in breakthrough and therefore recognized at first as an asset. As the services of the costs are recognized, the connected asset account is decreased and also expensed. The most common species of prepaid costs are prepaid rent and prepaid insurance.


Common reasons for Prepaid Expenses

The 2 most typical uses of prepaid prices are rent and also insurance.

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

Initial journal entry for prepaid rent:

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Adjusting newspaper entry together the prepaid rent expires:

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2. Prepaid insurance is insurance payment in advance and that has actually not however expired top top the date of the balance sheetBalance SheetThe balance sheet is among the three an essential financial statements. The financial statements are key to both gaue won modeling and accounting..

Initial journal entry for prepaid insurance:

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Adjusting journal 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 firm A pays the annual amount ($120,000) upfront at the start of the year.

The initial newspaper entryJournal Entries GuideJournal Entries are the structure blocks of accounting, from reporting to auditing journal entries (which consists Debits and also Credits) for company A would certainly be together follows:

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At the end of one month, agency A would’ve provided up one month the its lease agreement. Therefore, prepaid rent have to be adjusted:

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

The adjusting newspaper entry is excellent each month, and at the end of the year, once the lease agreement has no future financial benefits, the prepaid rental balance would certainly be 0.

Example #2

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

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

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

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

The adjusting newspaper entry is excellent each month, and at the finish of the year, when the insurance policy has actually no future economic benefits, the prepaid insurance balance would be 0.

Effect of Prepaid expenses on jae won Statements

The initial journal entry for a prepaid price does not impact a company’sfinancial statements. For example, describe the very first example of prepaid rent. The initial journal entry because that prepaid rent is a debit to prepaid rent and also a credit transaction to cash.

These space both legacy accounts and also do not rise or to decrease a company’s balance sheet. Recall the prepaid prices are considered an asset since they provide future economic benefits to the company.

The adjusting newspaper entry for a prepaid expense, however, does impact both a company’s income statement and also balance sheet. Refer to the first example that prepaid rent. The adjusting entry on January 31 would result in an cost of $10,000 (rent expense) and also a to decrease in assets of $10,000 (prepaid rent).

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The cost would display up top top the revenue statement when the to decrease in prepaid rental of $10,000 would alleviate the assets on the balance paper by $10,000.

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