Prepaid expenses are future expenses paid in advance but which has not yet been incurred during the current period. Prepaid expenses are shown on the balance sheet under asset side.
There are two accounts involves to record the prepaid expense entry, initially you have to record under current assets , but these prepaid expenses are become expenses over the period.
According to the accounting rules prepaid expenses are debit (Asset) and credit to the cash or bank account
ABC company has paid one year advance rent of $1,20,000 on 1st October 2016 and ABC has to pay every month rent of $10,000 and the company financial is April to March. You have to post October-2016 rent expenses on October month end adjusting/ reversing against to prepaid expenses (Balance Sheet A/c).
Advance rent paid on 1st October-2016
Prepaid Rent Account Dr $1,20,000 (Under Current Assets)
To Bank or Cash $1,20,000 (Under Bank Accounts)
Rent paid adjustment entry for the October 2016
Office Rent Account Dr $10,000 (Expenses Account)
To Prepaid Rent Account $10,000
Or, you can post single adjustment entry for the whole year, as per the above example you can post adjustment entry for six months on 31.03.2017 ($10,000*6 =$60,000)
Adjustment entry for the financial year 2016 -2017
Office Rent Account Dr $60,000 (Expenses Account)
To Prepaid Rent Account $60,000
You have to record expenses on proportionate basis i.e. as per the company financial year (Apr – Mar) you have to record rent expenses of $60,000 for the period of October 2016 to March 2017. You can post month wise adjustment entry like above or post year end single adjustment entry for six months as shown above and the remaining balance will appear under current assets.
Example 2: Prepaid Insurance
Generally insurance paid on monthly or year basis.
Example, Prepaid insurance paid by ABC Company for the period 1st September 2016 to August -2017 of $12,000 and the ABC financial year is April to March.
Prepaid insurance paid on 01-09-2016
Prepaid Insurance Account Dr $12,000 (Under Current Assets)
To Bank Account $12,000 (Under Bank Accounts)
Year end adjustment/reverse entry 31-03-2017
You have to post adjustment entry on proportionate basis for current financial year i.e. from September 2016 to March 2017.
Insurance Expenses Account Dr $7,000 (Under Expenses)
To Prepaid Insurance Account $7,000
You can post the above entry month wise or single entry on financial year end and remaining balance will appear under current assets of $5,000.