Adjusting Entries for Asset Accounts

Unearned revenues are money received before work has been performed and is recorded as a liability. Prepaid expenses are expenses the company pays for in advance and are assets including things like rent, insurance, supplies, inventory, and other assets. Regardless of whether it’s insurance, rent, utilities, or any other expense that’s paid in advance, it should be recorded in the appropriate prepaid asset account. Prepaid insurance premiums and rent are two common examples of deferred expenses. If the rent is paid in advance for a whole year but recognized on a monthly basis, adjusting entries will be made every month to recognize the portion of prepayment assets consumed in that month.

Check if the portion of the service you have used so far is written off. This will bring down the balance of the Prepaid Insurance account and increase your Insurance Expense. When a company prepays for an expense, it is recognized as a prepaid asset on the balance sheet, with a simultaneous entry being recorded that reduces the company’s cash (or payment account) by the same amount. Most prepaid expenses appear on the balance sheet as a current asset unless the expense is not to be incurred until after 12 months, which is rare. As each month passes, one rent payment is credited from the prepaid rent asset account, and a rent expense account is debited. This process is repeated as many times as necessary to recognize rent expense in the proper accounting period.

• Expenses are recognized when they are incurred regardless of when paid.
• Prepaid insurance is essentially a part of the insurance premium or a fee that is paid by the company in advance as a part of the insurance agreement for an extended period of time.
• Each month, you will need to move the used portion of the insurance payment to an expense account.
• This will bring down the balance of the Prepaid Insurance account and increase your Insurance Expense.

Notice that the ending balance in the asset Accounts Receivable is now $7,600—the correct amount that the company has a right to receive. The income statement account balance has been increased by the $3,000 adjustment amount, because this $3,000 was also earned in the accounting period but had not yet been entered into the Service Revenues account. The balance in Service Revenues will increase during the year as the account is credited whenever a sales invoice is prepared.

Journal Entry for Prepaid Expenses

Now, that we understand this, what journal entries will one make to record the $100 worth of insurance used and the $1,100 worth of prepaid insurance remaining? To answer this, let’s discuss the journal entry for prepaid insurance. In the business, the company usually needs to make an advance payment for the insurance that it has purchases.

Thus, out of the $1,500, $900 worth of supplies have been used and $600 remain unused. The $900 must then be recognized as expense since it has already been used. Expenses are recognized when they are incurred regardless of when paid. Expenses are considered incurred when they are used, consumed, utilized or has expired. This article is not intended to provide tax, legal, or investment advice, and BooksTime does not provide any services in these areas. This material has been prepared for informational purposes only, and should not be relied upon for tax, legal, or investment purposes.

Organizations typically use a prepaid expense ledger to monitor the total amount of money spent on prepayments, when payments are due, and when they will be received. This helps ensure that companies are accurately accounting for their assets while also staying up-to-date with any upcoming liabilities. The $25,000 balance in Equipment is accurate, so no entry is needed in this account.

What are Prepaid Expenses?

Interest paid in advance may arise as a company makes a payment ahead of the due date. Meanwhile, some companies pay taxes before they are due, such as an estimated tax payment based on what might come due in the future. Other less common prepaid expenses might include equipment rental or utilities. Similar to an accrual or deferral entry, an adjusting journal entry also consists of an income statement account, which can be a revenue or expense, and a balance sheet account, which can be an asset or liability. The payment of expense in advance increases one asset (prepaid or unexpired expense) and decreases another asset (cash).

The balance at the end of the accounting year in the asset Prepaid Insurance will carry over to the next accounting year. A prepaid expense is a type of asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. Prepaid expenses are initially recorded as assets, but their value is expensed over time onto the income statement. The adjusting journal entry for a prepaid expense, however, does affect both a company’s income statement and balance sheet. 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). Expenses that are used to make payments for goods or services that will be received in the future are known as prepaid expenses.

The income statement for the quarter ending will, therefore, show an insurance expense of $2,500 under the line item of Insurance Expense. Whereas, in the company’s balance statement, the closing balance of the current prepaid insurance account will show a balance journal entry definition of $7,500 ($10,000- $2,500) for the quarter ending. Then, in each successive month for the next twelve months, there would be adjusting entries of prepaid insurance that debit the insurance expense account and credit the prepaid insurance account by $100.

In order to adjust the entry for prepaid insurance, the amount of expired insurance has to be determined. Once this is done, the amount is recorded as a debit to insurance expense and a credit to prepaid insurance. This adjusting entry effectively increases the amount recognized as expenses and reduces the amount left as assets within the allotted period.

Which of these is most important for your financial advisor to have?

To deal with the mismatches between cash and transactions, deferred or accrued accounts are created to record the cash payments or actual transactions. In accrual accounting, revenues and the corresponding costs should be reported in the same accounting period according to the matching principle. The revenue recognition principle also determines that revenues and expenses must be recorded in the period when they are actually incurred.

There are numerous examples of cases when companies and individuals pay for expenses they are sure they will incur in the future ahead of time. However, in practice, revenues might be earned in one period, and the corresponding costs are expensed in another period. Also, cash might not be paid or earned in the same period as the expenses or incomes are incurred.

The amount of time a prepaid expense is reported as an asset should correspond with how long the payment will provide a benefit to the organization, usually up to 12 months. Prepaid or unexpired expenses can be recorded under two methods – asset method and expense method. The ending balance in the contra asset account Accumulated Depreciation – Equipment at the end of the accounting year will carry forward to the next accounting year.

Unit 4: Completion of the Accounting Cycle

If the prepaid insurance account is not adjusted in tandem with the portion of the insurance that has expired, it will lead to errors in reporting the assets and expenses of the company. Therefore, timely and accurate adjustments to the prepaid insurance account are essential for correct financial statements per time. The income statement account Insurance Expense has been increased by the $900 adjusting entry. It is assumed that the decrease in the amount prepaid was the amount being used or expiring during the current accounting period. The balance in Insurance Expense starts with a zero balance each year and increases during the year as the account is debited.

Let’s assume the review indicates that the preliminary balance in Accounts Receivable of $4,600 is accurate as far as the amounts that have been billed and not yet paid. Adjusting journal entries are used to (you guessed it) adjust the balances in certain accounts due to the passage of time. At the end of each month, an adjusting entry of $400 will be recorded to debit Insurance Expense and credit Prepaid Insurance.

Example – Journal Entry for Prepaid Rent

Keeping proper financial records is time-intensive and small mistakes can be costly. BooksTime makes sure your numbers are 100% accurate so you can focus on growing your business. The premium covers twelve months from 1 September 2019 to 31 August 2020, i.e., four months of 2019 and eight months of 2020.