For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. If your company reports quarterly, by March 31, 2023, a quarter of the insurance has expired. On December 29, 2022, you prepay $18,000 for a year’s insurance on a delivery Accounting For Architects truck, covering January to December 2023.

Introduction to Adjusting Journal Entries Video Summary

The expenditure was initially recorded into a prepaid account on the balance sheet. The alternative approach is the “income statement approach,” wherein the Expense account is debited at the time of purchase. The appropriate end-of-period adjusting entry establishes the Prepaid Expense account with a debit for the amount relating to future periods. The offsetting credit reduces the expense to an amount equal to the amount consumed during the period.

• The balance in Service Revenues will increase during the year as the account is credited whenever a sales invoice is prepared.
• But seriously, accurate accounting is key to knowing whether you’re making dough or burning it.
• Company-B paid 60,000 rent (5,000 x 12 months) in the month of December which belongs to the next year and doesn’t become due until January of the following year.
• This will be discussed later when we prepare adjusting journal entries.
• Prepaid insurance might sound like accounting voodoo, but trust me, it’s way less scary than it seems.
• Prepaid expenses only turn into expenses when you actually use them.

Example: Adjusting Prepaid Rent

• The premium paid before the commencement of the insurance period is a prepaid expense.
• Revenue which has been received but not yet earned is transferred to the balance sheet as a liability (deferred revenue).
• This should be the debit balance in Accounts Receivable minus the credit balance in Allowance for Doubtful Accounts.
• Similarly, the amount not yet allocated is not an indication of its current market value.
• In order to safeguard their assets, businesses pay insurance premiums upfront.

Here are the Prepaid Insurance and Insurance Expense ledgers AFTER the adjusting entry has been posted. Here are the ledgers that relate to the purchase of prepaid insurance when the transaction above is posted. Until next time, keep those ledgers balanced and those expenses accounted for.

Initial Recognition of Prepaid Expenses

Credit the corresponding account you used to make the payment, like a Cash or Checking account. Prepaid insurance is adjusted to account for the portion of the insurance that has expired over the accounting period. This ensures your financial statements accurately reflect your assets adjusting entries for prepaid insurance and expenses, preventing any misrepresentation of your company’s financial health. Then, every month for the next twelve months, ABC Company makes adjusting entries to debit the insurance expense account and credit the prepaid insurance account by $100. It’s like peeling off a layer of an onion—only with less crying (hopefully).

As you use up the prepaid item, the asset decreases, and the expense shows up on the income statement. At each reporting period, the appropriate portion of the prepaid amount is transferred from the asset account to an expense account. The journal entry is debiting insurance expense $ 1,000 and credit unexpired insurance $ 1,000.

Adjusting entries for prepaid expense

When the insurance period begins, you slowly transfer a portion of the amount from the asset account to the expense account. Insurance is typically purchased by prepaying for an annual or semi-annual policy. Or, rent on a building may be paid ahead of its intended use (e.g., most landlords require monthly rent to be paid at the beginning of each month).

Understanding Goodwill in Balance Sheet – Explained

After four months, the company needs to recognize the rent expense for those months. The https://dfolalitpur.gov.np/what-is-the-procedure-for-preparing-a-trial/ adjusting entry would debit Rent Expense for $8,000 (4 months x $2,000/month) and credit Prepaid Rent for $8,000. This reduces the prepaid rent asset and recognizes the expense in the correct period, ensuring accurate financial statements.