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Prepaid expenses

Also known as paid in advance expenses and Un-expired Expenses

These expenses have been paid in advance but the business has not yet incurred or used up these expenses.

For instance a company had telephone expenses amounting to $2000 and made an entry for these expenses in its books, but at the end of accounting period the company used the telephone service for $500. Since the remaining $1500 pertain to next accounting period, they must be considered as prepaid expenses and these $1500 expenses should not be included in telephone expenses for this accounting period

Nature of Prepaid expenses

Since prepaid expenses have future economic benefits and these expenses are resources of the business, prepaid expenses are treated as Assets of  the business

Double entry for prepaid expenses

DEBIT = Prepaid expenses account

CREDIT = Expenses account

Example

Mr. Z started a bakery business on 1st January 2012. A building which was on rent was used for the purpose of business. The rent of building was payable at the start every 3 months in advance

The detail of rent expense payments is as follows:


Amount of Expenses
Expense due on
Expenses paid on

   $500
   $500
   $500
   $500
   $500

   31 March 2012
   30 June 2012
   30 September 2012
   31 December 2012
   31 March 2013

   3 January 2012
   27 march 2012
   29 June 2012
   2 October 2012
   27 December 2012
   


Requirement: You are required to calculate the amount expenses pertaining to this accounting period or The amount of expenses that should be charged in income statement for the year ended on 31 December, 2012

Solution:

These double or journal entries were made by business at the time of expenses payments

On  3 January 2012   Mr. Z  paid cash $500 for the use of building which was an advance payment

  DESCRIPTION DEBIT CREDIT



  Rent expenses   $500



               Cash   $500




On  27 march 2012 Mr. Z  again paid $500 to the building's owner in advance

  DESCRIPTION DEBIT CREDIT



   Rent expenses   $500



               Cash   $500




On  29 June, 2012  Mr. Z  paid $500 for the use of building  that payment was made in advance

  DESCRIPTION DEBIT CREDIT



   Rent expenses   $500



               Cash   $500




On 2 October, 2012 Mr. Z  paid telephone expenses for 3 months in advance

  DESCRIPTION DEBIT CREDIT



   Rent expenses   $500



               Cash   $500




On 27 December 2012 Mr. Z  paid $500 before the end of accounting period. Since the business has not used up these expenses in this accounting period, these expenses are not related to this period and should be recorded in the next period not in this accounting period. Therefore, the business has made an adjusting entry for these prepaid expenses on 31 December, 2012 which excludes these expenses from total rent expenses for this year

The following adjusting entry was made on 31 December, 2012 to allocate expenses to this accounting period

  DESCRIPTION DEBIT CREDIT



   Prepaid Rent expenses   $500



               Rent expenses   $500




Now you just have to post the above journal entries in Telephone account to find out the "Total telephone expenses" for this accounting period




DEBIT
Rent expenses A/C*



CREDIT
DATE
DESCRIPTION
AMOUNT
DATE
DESCRIPTION
AMOUNT
Jan. 3
Mar. 27
Jun. 29
Oct. 2
Dec. 27
Cash
Cash
Cash
Cash
Cash
$500
$500
$500
$500
$500
Dec. 31
Dec. 31
Income statement (BF*)
Prepaid expenses
$2000
$500

TOTAL $2500
TOTAL $2500

$2000 is "Total amount of expenses" that should be charged to this accounting. These expenses will be shown in income statement

*A/C=Account
* BF=Balancing figure