Which expenses are paid and recorded in an asset account before they are used or consumed?
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Future expenses that are paid in advance Show
What are 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 as assets, because they have future economic benefits, and are expensed at the time when the benefits are realized (the matching principle). Summary
Common Reasons for Prepaid ExpensesThe two most common uses of prepaid expenses are rent and insurance. 1. Prepaid rent is rent paid in advance of the rental period. The journal entries for prepaid rent are as follows: Initial journal entry for prepaid rent:
2. Prepaid insurance is insurance paid in advance and that has not yet expired on the date of the balance sheet. Initial journal entry for prepaid insurance: Adjusting journal entry as the prepaid insurance expires: Prepaid Expenses ExampleWe will look at two examples of prepaid expenses: Example #1Company A signs a one-year lease on a warehouse for $10,000 a month. The landlord requires that Company A pays the annual amount ($120,000) upfront at the beginning of the year. The initial journal entry for Company A would be as follows: At the end of one month, Company A would’ve used up one month of its lease agreement. Therefore, prepaid rent must be adjusted: Note: One month corresponds to $10,000 ($120,000 x 1/12) in rent. The adjusting journal entry is done each month, and at the end of the year, when the lease agreement has no future economic benefits, the prepaid rent balance would be 0. Example #2Upon signing the one-year lease agreement for the warehouse, the company also purchases insurance for the warehouse. The company pays $24,000 in cash upfront for a 12-month insurance policy for the warehouse. The initial journal entry for Company A would be as follows: At the end of one month, Company A would have used up one month of its insurance policy. Therefore, prepaid insurance must be adjusted: Note: One month corresponds to $2,000 ($24,000 x 1/12) in insurance policy. The adjusting journal entry is done each month, and at the end of the year, when the insurance policy has no future economic benefits, the prepaid insurance balance would be 0. Effect of Prepaid Expenses on Financial StatementsThe initial journal entry for a prepaid expense does not affect a company’s financial statements. For example, refer to the first example of prepaid rent. The initial journal entry for prepaid rent is a debit to prepaid rent and a credit to cash. These are both asset accounts and do not increase or decrease a company’s balance sheet. Recall that prepaid expenses are considered an asset because they provide future economic benefits to the company. The adjusting journal entry for a prepaid expense, however, does affect both a company’s income statement and balance sheet. Refer to the first example of prepaid rent. 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). The expense would show up on the income statement while the decrease in prepaid rent of $10,000 would reduce the assets on the balance sheet by $10,000. More ResourcesThank you for reading CFI’s guide to Prepaid Expenses. To keep learning and advancing your career, the following CFI resources will be helpful:
What is an expense account which has been paid for in advance of its use?Prepaid expenses are future expenses that are paid in advance, such as rent or insurance. On the balance sheet, prepaid expenses are first recorded as an asset.
In which account payment for expenses are recorded?In accounting, these payments or prepaid expenses are recorded as assets on the balance sheet. Once incurred, the asset account is reduced, and the expense is recorded on the income statement.
When an item of expense is paid and recorded in advance before it is incurred it is normally called a n?14. When an item of expense is paid and recorded in advance, it is normally called a(n) a. prepaid expense.
Why prepaid expenses is an asset?Why are prepaid expenses considered assets? Prepaid expenses are recorded as an asset on a business's balance sheet because they signify a future benefit that is due to the company. Prepaid expenses are amounts paid in advance by a business in exchange for goods or services to be delivered in the future.
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