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    The Accounting Cycle - Part3

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    Raaiina
    The document discusses how to account for prepayments under the expense method and asset method. Under the expense method, prepayments are initially recorded as an expense and then adjusted at the end of the period to record the unused portion as an asset by debiting prepaid expense and crediting the original expense account. Under the asset method, prepayments are initially recorded as an asset and then adjusted at the end of the period to record the used portion as an expense by debiting expense and crediting the original asset account. The adjustments ensure expenses are accurately matched to the period incurred.

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    The Accounting Cycle - Part3

    Uploaded by

    Raaiina
    7 views10 pages
    The document discusses how to account for prepayments under the expense method and asset method. Under the expense method, prepayments are initially recorded as an expense and then adjusted at the end of the period to record the unused portion as an asset by debiting prepaid expense and crediting the original expense account. Under the asset method, prepayments are initially recorded as an asset and then adjusted at the end of the period to record the used portion as an expense by debiting expense and crediting the original asset account. The adjustments ensure expenses are accurately matched to the period incurred.

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    The Accounting Cycle_Part3

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    The document discusses how to account for prepayments under the expense method and asset method. Under the expense method, prepayments are initially recorded as an expense and then adjusted at the end of the period to record the unused portion as an asset by debiting prepaid expense and crediting the original expense account. Under the asset method, prepayments are initially recorded as an asset and then adjusted at the end of the period to record the used portion as an expense by debiting expense and crediting the original asset account. The adjustments ensure expenses are accurately matched to the period incurred.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as pdf or txt
    7 views10 pages

    The Accounting Cycle - Part3

    Uploaded by

    Raaiina
    The document discusses how to account for prepayments under the expense method and asset method. Under the expense method, prepayments are initially recorded as an expense and then adjusted at the end of the period to record the unused portion as an asset by debiting prepaid expense and crediting the original expense account. Under the asset method, prepayments are initially recorded as an asset and then adjusted at the end of the period to record the used portion as an expense by debiting expense and crediting the original asset account. The adjustments ensure expenses are accurately matched to the period incurred.

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    © All Rights Reserved
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    of 10

    Business

    Transactions
    &
    The Accounting
    Cycle
    The Accounting Cycle
    5. PREPARATION OF THE WORKING PAPER WITH
    ADJUSTMENTS

    PREPAYMENTS (PREPAID EXPENSE) – items already


    paid but not yet incurred as at end of the period

    Ex. (1) Unused supplies; (2) Prepaid rent; (3) Prepaid


    advertising

    METHODS OF ACCOUNTING FOR PREPAYMENTS


    1. Expense Method
    2. Asset Method
    The Accounting Cycle
    5. PREPARATION OF THE WORKING PAPER WITH ADJUSTMENTS

    PREPAYMENTS – Expense Method of Accounting


    Under this method, an EXPENSE account is debited at the time of
    payment.

    Pro-forma Journal Entries:


    Entry to record the prepayment at the time of payment:

    Dr. Expense xx
    Cr. Cash xx

    Entry to adjust for the unused/ unexpired portion of the


    prepayment as at end of the period:

    Dr. Asset (prepaid or unused account) xx


    Cr. Expense xx
    The Accounting Cycle
    5. PREPARATION OF THE WORKING PAPER WITH ADJUSTMENTS

    PREPAYMENTS – Expense Method of Accounting


    Illustration: On October 01, 2020, the business paid rentals of
    P120,000 covering 1 – year rent which runs from October 01, 2020 to
    October 01, 2021. The accounting year of the business ends every
    December 31.

    Entry made by the business on October 01, 2020 (for illustration


    purposes only, not part of the actual adjusting entry at year-end):
    Rent expense P 120,000
    Cash P120,000

    Adjusting journal entry as at December 31, 2020


    Prepaid rent P 90,000
    Rent expense P 90,000
    The Accounting Cycle
    5. PREPARATION OF THE WORKING PAPER WITH ADJUSTMENTS

    PREPAYMENTS – Expense Method of Accounting


    Explanation of the adjustment:
    Adjusting journal entry as at December 31, 2020
    Prepaid rent P 90,000
    Rent expense P 90,000

    NOTE: Prior to the preparation of the adjusting entry, the amount of


    rent expense for the year 2020 is overstated since the entire P120,000
    was recorded by the business as RENT EXPENSE on October 01, 2020
    (time of payment). But as at cut-off date for reporting (December
    31, 2020), only 3 months of rent have been incurred by the business,
    hence, the RENT EXPENSE should only amount to P30,000 for the
    period ended December 31, 2020 (P120,000 x 3/12). Accordingly,
    RENT EXPENSE for the year must be reduced by P90,000 and a
    PREPAID RENT (asset) account must be established equal to the
    P90,000, the unused portion of the prepayment as at year – end.
    The Accounting Cycle
    5. PREPARATION OF THE WORKING PAPER WITH ADJUSTMENTS

    PREPAYMENTS – Expense Method of Accounting


    Explanation of the adjustment:
    Adjusting journal entry as at December 31, 2020
    Prepaid rent P 90,000
    Rent expense P 90,000

    NOTE:
    1. The adjusting entry involving prepayments accounted for under
    the EXPENSE METHOD includes a DEBIT to an ASSET account and a
    CREDIT to an EXPENSE account equal to the UNEXPIRED (UNUSED)
    portion of the prepayment.

    2. Note also that the adjustment involves only two accounts, ASSET
    and EXPENSE accounts. The DEBIT in the adjusting entry is always
    opposite the method. Hence, if the method used is EXPENSE
    method, the DEBIT in the entry is always an ASSET account. Needless
    to say, the CREDIT is the same as the method (EXPENSE account)
    The Accounting Cycle
    5. PREPARATION OF THE WORKING PAPER WITH ADJUSTMENTS

    PREPAYMENTS – Asset Method of Accounting


    Under this method, an ASSET account is debited at the time of
    payment.

    Pro-forma Journal Entries:


    Entry to record the prepayment at the time of payment:

    Dr. Asset (prepaid or unused account) xx


    Cr. Cash xx

    Entry to adjust for the used/ expired portion of the prepayment as at


    end of the period:

    Dr. Expense xx
    Cr. Asset (prepaid or unused account) xx
    The Accounting Cycle
    5. PREPARATION OF THE WORKING PAPER WITH ADJUSTMENTS

    PREPAYMENTS – Asset Method of Accounting


    Illustration: On October 01, 2020, the business paid rentals of
    P120,000 covering 1 – year rent which runs from October 01, 2020 to
    October 01, 2021. The accounting year of the business ends every
    December 31.

    Entry made by the business on October 01, 2020 (for illustration


    purposes only, not part of the actual adjusting entry at year-end):
    Prepaid rent P 120,000
    Cash P120,000

    Adjusting journal entry as at December 31, 2020


    Rent expense P 30,000
    Prepaid rent P 30,000
    The Accounting Cycle
    5. PREPARATION OF THE WORKING PAPER WITH ADJUSTMENTS

    PREPAYMENTS – Asset Method of Accounting


    Explanation of the adjustment:
    Adjusting journal entry as at December 31, 2020
    Rent expense P 30,000
    Prepaid rent P 30,000

    NOTE: Prior to the preparation of the adjusting entry, the amount of


    Prepaid rent (asset) for the year 2020 is overstated since the entire
    P120,000 was recorded by the business as PREPAID RENT on October
    01, 2020 (time of payment). But as at cut-off date for reporting
    (December 31, 2020), 3 months of rent have already been incurred
    by the business, hence, RENT EXPENSE equal to P30,000 for the period
    ended December 31, 2020 (P120,000 x 3/12) must be recognized.
    Accordingly, PREPAID RENT as at year-end must be reduced by
    P30,000 and a RENT EXPENSE account must be established equal to
    P30,000, the used portion of the prepayment as at year – end.
    The Accounting Cycle
    5. PREPARATION OF THE WORKING PAPER WITH ADJUSTMENTS

    PREPAYMENTS – Asset Method of Accounting


    Explanation of the adjustment:
    Adjusting journal entry as at December 31, 2020
    Rent expense P 30,000
    Prepaid rent P 30,000

    NOTE:
    1. The adjusting entry involving prepayments accounted for under
    the ASSET METHOD includes a DEBIT to an EXPENSE account and a
    CREDIT to an ASSET (prepaid/unused) account equal to the EXPIRED
    (USED) portion of the prepayment.

    2. Note also that the adjustment involves only two accounts, ASSET
    and EXPENSE accounts. The DEBIT in the adjusting entry is always
    opposite the method. Hence, if the method used is ASSET method,
    the DEBIT in the entry is always an EXPENSE account. Needless to
    say, the CREDIT is the same as the method (ASSET account)

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