chapter 3 Tips Prepaid Expenses and Unearned Revenues PG 10

chapter 3 Tips Prepaid Expenses and Unearned Revenues PG 10...

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4/1 1,200 12/31 Adj. 12/31 Sal. 900 Chapter 3 Review of the Accounting Process **ILLUSTRATION 3-4 ALTERNATIVE TREATMENTS OF PREPAID EXPENSES AND UNEARNED REVENUES When a company writes a check to pay for an item that affects expense in at least two different time periods (such as for an insurance premium or a license or dues), the bookkeeper may record the payment in one of two ways. Either as a prepaid expense (asset) or as an expense. The first way is used most often in introductory accounting textbooks; the second is used most often in the real world. Regardless of the way the payment is recorded, an appropriate adjusting entry will be made at the end of the accounting period so that correct balances appear on the income statement and the balance sheet. For example, a $1,200 payment is made on April 1, 2007, for a twelve-month insurance premium covering the time between April 1, 2007 and March 31, 2008. (Assume a
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Unformatted text preview: calendar year reporting period.) A comparison of the two possible approaches appears below. Prepayment (Cash Paid) Prepayment (Cash Paid) Initially Debited to Asset Account OR Initially Debited to Expense Account 4/1 Prepaid Insurance 1,20 0 4/1 Insurance Expense 1,200 Cash 1,200 Cash 1,200 12/31 Insurance Expense 900 12/31 Prepaid Insurance 300 Prep aid Insurance 900 Insurance Exp ense 300 After posting the entries, the accounts appear as follows: Prepaid Insurance 4/1 1,200 12/31 Adj. 12/31 Sal. 300 900 Prepaid Insurance 12/31 Adj. 300 Insurance Expense Insurance Expense 12/31 Adj. 300 Notice that regardless of the path, you end up at the same place-with a balance of $300 in Prepaid Insurance and a balance of $900 in Insurance Expense. That was your objective-to report balances in accordance with the accrual basis of accounting....
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