Introduction to Adjusting Journal Entries and Prepaid Expenses Accounting Video

Adjusting journal entries are used to adjust the balances in certain accounts due to the passage of time. Adjusting entries are made at the end of an accounting period.

• 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 by the same amount.
• Prepaid insurance is a kind of prepayment that stands for the instalments made for the expenses which have not been procured yet.
• Insurance Expense, also called Insurance Premium, is the amount a Company pays to obtain an insurance contract for covering their risk from any unexpected catastrophe.

Once the adjusting entries passed, the adjusted trial balance is being prepared. One of the adjusting entries is the journal entry of prepaid insurance. When the insurance policy prepaid insurance journal entry is bought and the premium is paid, the prepaid insurance account is debited in the books. This prepaid insurance account is written-off throughout the insurance policy.

“Why is it easier for someone to perpetrate fraud using a journal entry than with a ledger?”

Then, over a period of six months, that premium will be “used”. Adjusting Entries are journal entries made at the end of the accounting period in order to bring the books into alignment with the matching and revenue recognition principles required by GAAP . They help accountants to better match revenues and expenses to the accounting period in which the activity took place. Their purpose is to more accurately reflect the business activity that occurred during an accounting period, regardless of when the actual invoicing, billing and cash exchanged hands. These entries bring corporate financial statements into compliance with the matching and revenue recognition principles. They are a necessary part of the accrual accounting process and a very important part of the accounting cycle. Companies purchase insurance coverage by paying insurance premiums and record related transactions accordingly.

The prepaid rent/insurance account and cash/cheque in the above examples are asset accounts. With their zero net effect, the balance sheet will not increase or decrease. The initial entry for the prepaid expenses will have no effect on the financial statements of an entity. It will neither change the profit & loss statement nor the balance sheet. The prepaid insurance account will be credited and insurance expenses will be debited.

Presentation of Prepaid Insurance

Companies record expired insurance periodically based on the intersection of their accounting periods and the time structure of the insurance. At the end of the insurance term, the total insurance expires and companies would have fully recorded the total prepaid insurance as expenses over multiple periods. A small company has an insurance contract under which the total premium of $48,000 must be paid in advance for 12 months of coverage under a general liability insurance policy.

For example, office supplies are considered an asset until they are used in the course of doing business, at which time they become an expense. At the end of each accounting period, adjusting entries are necessary to recognize the portion of prepaid expenses that have become actual expenses through use or the passage of time. Prepaid expenses may need to be adjusted at the end of the accounting period. The adjusting entry for prepaid expense depends upon the journal entry made when it was initially recorded.

Prepaid expense vs. Prepaid insurance

An advance payment is made ahead of its normal schedule such as paying for a good or service before you actually receive it. The insurance used for December will be reported as an Insurance Expense on December’s income statement. Let us look at the balance sheet at the end of one month on December 31, 2017. On the other hand, liabilities, equity, and revenue are increased by credits and decreased by debits. Unearned Revenue – money that you have been given for the promise of providing a product, service or work in the future.

• The adjusting entry for prepaid expense will depend upon the initial journal entry, whether it was recorded using the asset method or expense method.
• Prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract.
• Any adjustments to Cash should be made in with the bank reconciliation, or as a correcting entry.
• Peggy James is a CPA with over 9 years of experience in accounting and finance, including corporate, nonprofit, and personal finance environments.
• DateAccountNotesDebitCreditX/XX/XXXXPrepaid Expense1800Cash1800Each month, adjust the accounts by the amount of the policy you use.
• From the above examples, the expenses will be shown in the profit & loss statement while prepaid rent/insurance will reduce the assets on the balance sheet.

Likewise, the adjusting entry at the end of the period is necessary for the company to recognize the cost that expires through the passage of time. Assume a company ABC purchases insurance for the upcoming 12-month period and pays $180,000 upfront for it. ABC Company will initially book the full $180,000 as a debit to prepaid insurance, an asset on the balance sheet, and a credit to cash. Each month, an adjusting entry will be https://www.bookstime.com/ made to expense $15,000 (1/12 of the prepaid amount) to the income statement through a credit to prepaid insurance and a debit to insurance expense. In the 12th month, the final $15,000 will be fully expensed and the prepaid account will be zero. Initial journal entries do not affect the company’s financial statements. Prepaid rent and credit to cash are asset accounts and do not increase or decrease a company’s balance sheet.

An Example of Prepaid Insurance Accounting

By making this journal entry, the company will be able to record the insurance expense which has been incurred already and the part of prepaid insurance which has now already expired. When managing a business, particularly a small one, owners are to make sure that money is provided for all the goods and services that tend to increase the potential revenue. However, quite frequently, paid services cannot be provided timely, being transferred to the unearned service revenue (Weygandt, Kimmel, & Kieso, 2015). At the end of the accounting period, these entries are to be adjusted based on whether they start bringing earned revenue to the overall business profits. Understand the basic accounting process for pre-paid expenses.

You accrue a prepaid expense when you pay for something that you will receive in the near future. Any time you pay for something before using it, you must recognize it through prepaid expenses accounting. For example, if the accounting period is quarterly, for the $12,000 pre-payment, each quarter would see $3,000 move from the Prepaid Insurance asset account, to the Insurance Expense account. After quarter 1, the Prepaid Insurance account would have a value of $9,000, and by the end of the fourth quarter, the Prepaid Insurance account would have a balance of 0.

The process of deduction from the account periodically is often known as Amortization. Get up and running with free payroll setup, and enjoy free expert support. Try our payroll software in a free, no-obligation 30-day trial. This article was co-authored by Darron Kendrick, CPA, MA. Darron Kendrick is an Adjunct Professor of Accounting and Law at the University of North Georgia. He received his Masters degree in tax law from the Thomas Jefferson School of Law in 2012, and his CPA from the Alabama State Board of Public Accountancy in 1984. Depreciation – the allocation of cost for a long-lived asset over the course of its estimated useful life.

The payroll expense for the two week period needs to be split between two years, with $1,500 in year 1 and $1,500 in year 2. X Company has a payroll department, and cuts checks every two weeks after tabulating hours, and calculating net pay.