Prepaid expenses



Section 3. Accrual basis accounting

Q14. Prepaid expenses
On December 1, 20×1, Entity A rented office space for one year and prepaid the $36,000 yearly rent.
What are the journal entries to be prepared on December 1 and 31, 20×1?

A14. Prepaid expenses are recorded on the debit side as an asset account.

(1) December 1, 20×1: to record the payment of prepaid rent expense

  Debit Credit
Prepaid rent expense 36,000  
     Cash   36,000

[Note]
1. Increase in prepaid rent expense (asset): debit
2. Prepaid rent expense is an asset account, because the prepaid portion of rent represents future economic benefits.

(2) December 31, 20×1: to record the rent expense for the month of December 20×1

  Debit Credit
Rent expense 3,000  
     Prepaid rent expense   3,000

[Note]
1. Increase in rent expense (expense): debit
2. Decrease in prepaid rent expense (asset): credit
3. Annual rent expense = $36,000
4. Monthly rent expense = $36,000 x 1/12 = $3,000

[Exercise]
On November 1, 20×1, Entity B paid $12,000 for insurance premium to cover 6 months ending on April 30, 20×2. Prepare journal entries on November 1 and December 31, 20×1.

(1) November 1, 20×1: to record the payment of prepaid insurance expense

  Debit Credit
Prepaid insurance expense 12,000  
     Cash   12,000

[Note]
1. Increase in prepaid insurance expense (asset): debit
2. Prepaid insurance expense is an asset account, because the prepaid portion of insurance premium will provide economic benefits in the future.

(2) December 31, 20×1: to record the insurance expense for the two-month period from November 1 to December 31, 20×1

  Debit Credit
Insurance expense 4,000  
     Prepaid insurance expense   4,000

[Note]
1. Increase in insurance expense (expense): debit
2. Decrease in prepaid insurance expense (asset): credit
3. Insurance expense for a 6-month period = $12,000
4. Monthly insurance expense = $12,000 x 1/6 = $2,000
5. Insurance expense for a two-month period = $2,000 x 2 = $4,000

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