Prepaid Expenses Journal Entry

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Journal Entry for Prepaid Expenses

The following different prepaid expenses journal entries explain the most common type of situations of how prepaid expenses are recorded and accounted for. As there are situations where the Journal Entry for Prepaid expense can be passed, it is impossible to provide all the situations.

How to Record Prepaid Expenses?

Example #1

Company X Ltd. started a business, and it requires the property for rent. It signed an agreement with Mr. Y to take the property on rent for one year. As per the agreement, X Ltd has to pay rent for the full 12 months in advance (at the beginning of the year on 01.01.2019) itself to the landlord, amounting to $ 60,000 for a whole year.

Also, after taking the property on rent and paying the amount of rent as an advance for one whole year, it took the insurance of the property, for which it paid $ 12,000 upfront for the insurance policy of the 12 months to the insurance company on 01.01.2019. Analyze the treatment of the amount paid as rent and insurance for the property by the company and pass the necessary journal entries recording the payment and the adjusting entries for January 2019.

Solution

The date when the rent and insurance expense are paid for the whole year:  January 01, 2019.

In the present case, company X ltd. paid the full rent and insurance amount for the 12 months at one time in the beginning. So, the X ltd will recognize the $ 60,000 rent expense and the $12,000 insurance expense as the prepaid insurance in the monthly financial statements of the company because the amount is paid in advance benefit, which is not yet received, and the same is to be received in the future date.

The company will initially record the amount paid as the prepaid expense at the time The company will initially record the amount paid as the prepaid expense at the time of payment of money and adjust it every month for the next 12 months as its expense once the amount gets due. Following are the accounting entry for recording rent and insurance expenses in the monthly financial statements for the year 2019:

Entry to record the payment of rent and Insurance amount in advance

Prepaid Expenses Journal Entry 1
Prepaid Expenses Journal Entry 1-1

Calculation of Expenses to be recognized monthly in the financial statements

Prepaid Expenses Journal Entry 1-2
Prepaid Expenses Journal Entry 1-3

The company will pass this adjusting journal entry every month for the next 12 months to prepare and present the correct monthly financial statement of the company, after which the balance of prepaid rent and insurance account will become nil.

Example #2

On December 31, 2018, Company Y Ltd paid the salaries for January 2019, amounting to $ 10,000 in advance to the company's employees. Analyze the treatment of the amount paid as an advance salary by the company to its employees and pass the necessary journal entries recording the payment and the adjusting entries.

Solution

At the accounting period ending in 2018, on December 31, 2018, the salary was paid in advance to the employees, which will be due in the next month. So in the present case, the company Y Ltd. paid the expense in one accounting year (ending on December 31, 2018), which will be due in the next accounting year (ending on December 31, 2019). The company has to recognize the payment as the prepaid expense in the accounting year in which it is paid and adjust the same when the expense gets due. The following are the necessary journal entries to record the transactions.

Example 2
Example 2-1

Explanation of Prepaid Expenses in Video

 

Conclusion

Prepaid expenses are the number of expenses paid in advance by one person to another, but the benefit is not yet received. The benefits of such expenses are to be utilized by the person on a future date. Once the amount has been paid for the expenses in advance (prepaid), a journal entry should be passed to record it on the date when it is paid. When the benefits have been received against it, the entry should be passed to record it as an actual expense in the books of accounts.

The adjusting journal entry should be passed at the end of every period to prepare and present the correct monthly financial statement of the company to the stakeholders.