Prepaid Expenses Examples, Accounting for a Prepaid Expense


On the financial statements, accrued revenue is reported as an adjusting journal entry under current assets on the balance sheet and as earned revenue on the income statement of a company. Remember that the unearned advertisement Revenues is a liability account, not a revenue account. The Advertisement Revenues will be earned gradually as Ocean Co. gives the services as promised. Because it will not be practical to record weekly or monthly earnings of revenues, what we do is to delay weekly or monthly earning until the end of the fiscal period.

The overstatement of expense leads to an understatement of net income . Decides to leave the office it rented on Dec.31,2002, do you think that it will be refunded the amount it paid of Jan. 1,2002? No, because it has already used the office for one year. As a result, the amount it should be refunded is the unused portion of the prepayment.

What Is the Journal Entry for Accrued Expenses?

The dividends account is closed directly to the Retained Earnings account. It is not closed to the Income Summary because dividends have no effect on income or loss for the period. The process of closing the temporary accounts is often referred to as closing the books. Accountants may perform the closing process monthly or annually.

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As you can recall, for both types of deferrals there are two methods of recording. That is, in the case of prepaid expenses the asset and expense methods and in the case of unearned revenues the liability and revenue methods of recording. Both alternative methods of recording deferrals result in the same effects on the financial statements. Then, the next logical question to ask is which method of recording to use.

The liability would be overstated in the Balance sheet because the adjustment has transferred out from the liability account to the revenue account the portion that is earned. But, if there was no adjustment this earned portion remains in the liability account and overstates it. The assets would be affected and understated, if the adjustment was over looked. Because it is through adjustment that we transfer the unexpired portion to the asset account. But if no adjustment, the unexpired portion remains in the expense account than being in the asset account.

What Are the Most Common Errors in Accounting?

Timely, reliable data is critical for decision-making and reporting throughout the M&A lifecycle. Without accurate information, organizations risk making poor business decisions, paying too much, issuing inaccurate financial statements, and other errors. Preparing financial statements requires preparing an adjusted trial balance, translating it into financial reports, and auditing them.

If your business typically receives payments from customers in advance, you will have to defer the revenue until it’s earned. One of your customers pays you $3,000 in advance for six months of services. However, his employees will work two additional days in March that were not included in the March 27 payroll. Tim will have to accrue that expense, since his employees will not be paid for those two days until April. Payroll expenses are usually entered as a reversing entry, so that the accrual can be reversed when the actual expenses are paid. In order to account for that expense in the month in which it was incurred, you will need to accrue it, and later reverse the journal entry when you receive the invoice from the technician.


An adjusting journal entry occurs at the end of a reporting period to record any unrecognized income or expenses for the period. Because of January 1 reversing entry that credited Salaries Expense for $3,500, Salaries Expense will have a debit balance of $4,500 which equals the expense for the current period. Option – The reversing entry can be related to the closing entries in case the closing entries were made incorrectly.

The merchandise inventory account before adjustment shows the inventory on hand at the beginning of the period. Lets once again present the model Income Statement that we saw at the beginning of this chapter. Please study the relationship between each item on the Income Statement carefully. Also try to remember how each item was recorded in journal entry form when the transactions affecting these accounts happened.

In this case, the amount in the Discount account will be deducted from Sales on the income statement. That way, we can disclose how much sales discount was offered and taken during the year on the income statement, separately. Most expenses in accounting are paid whenever they are incurred.

Accrued expenses theoretically make a company’s financial statements more accurate. While the cash method is more simple, accrued expenses strive to include activity that may not have fully been incurred but will still happen. Consider an example where a company enters into a contract to incur consulting services. If the company receives an invoice for $5,000, accounting theory states the company should technically recognize this transaction because it is contractually obligated to pay for the service. Prepare unadjusted trial balance, journalize and post adjusting entries, journalize transactions, post to ledger accounts. Journalize transactions, post to ledger accounts, prepare unadjusted trial balance, journalize and post adjusting entries.

liability account

This adjusting entry records months A’s portion of the interest expense with a journal entry that debits interest expense and credits interest payable. At the beginning of the month B that expense is reversed via a reversing entry. The entry credits interest expense and debits interest payable. When the full amount of the interest is paid in month B, each month’s books will show the proper allocation of the interest expense.

Adjusting entries allow you to adjust income and expense totals to more accurately reflect your financial position. Which of the following is not part of the recording process? Indicate how a change from LIFO to FIFO method for inventory valuation purposes is recorded in the accounting records in the current year of Coronet Co.

Periodic Inventory System- a system of recording inventories that updates inventory records only once in an accounting period. As you can see from the above Income Statements, merchandising companies have to pay to buy the goods that they sell. Therefore, they have to deduct this cost of goods sold in addition to other operating expenses from their sales revenue to determine their net income.


In corporations, this entry closes any dividend accounts to the retained earnings account. For purposes of illustration, closing entries for the Greener Landscape Group follow. Error of principle is recording an item that does not comport with Generally Accepted Accounting Principles .

  • The cash in a cash register equaled $100, but the record of cash receipts/sales equaled $102.
  • With small business accounting software, business owners and bookkeepers rarely have to make journal entries, as good accounting software will make the entry for you after you complete a form.
  • Sold merchandise to Terra Co. for $800 under credit terms of 2/10, n/60, FOB shipping point.
  • For the next 12 months, you will need to record $1,000 in rent expenses and reduce your prepaid rent account accordingly.
  • As soon as you spot an error, you should correct it in order to make sure your financial statements are accurate.

public accounting expenses are future expenses that are paid in advance and hence recognized initially as an asset. Understand accounting standards, so they are incorporated into your accounting system. Private companies based in the U.S. use GAAP for accounting. This dictates when and how income and expenses are reported.

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