Adjusting Journal Entries (Prepayment type)

which of the following is an example of a deferral (or prepaid) adjusting entry? This is a topic that many people are looking for. is a channel providing useful information about learning, life, digital marketing and online courses …. it will help you have an overview and solid multi-faceted knowledge . Today, would like to introduce to you Adjusting Journal Entries (Prepayment type). Following along are instructions in the video below:

“When we think of adjusting journal entries. There s really a couple types. So. One one is we ve got prepayment related.

Adjusting journal. Entries. And then we also have related. Adjusting journal entries.

In this video. We re going to talk about those of the prepayment variety. So what are we talking about when we look at prepayment adjusting journal entry. We ve really got a couple types.

So now we ve got we ve got some subcategories here we ve got prepaid expenses all right something like insurance you pay in advance for your insurance and you use it up as time passes and then we ve got things like unearned revenue. Where there s prepayment going on. But it s actually a prepayment on the part of your customer. And you haven t earned the revenue yet and so so let s just talk a little bit about about what is going on here.

So. When we think of these. Why an adjusting journal entry would need to be made with these these prepayment type entries. What we ve got is that the the account in question is basically expiring over time just slowly over time.

And it s not something that you would record on a daily basis or it s just something that s it s kind of like expiring as it s used up expire as used up like supplies or something like that and again you re not going to go every single second and make some kind of some kind of entry you just look at the end of the period. And see what s been used up. So let s go ahead and take a look here and see an example and we re going to take we re going to start with a prepaid expense. Okay that type of prepayment we re going to take a look at one of those and just see how play out in actual practice.

So let s take for our example..

That you purchase you. Purchase a 12. Month insurance. Policy 12 month policy for 12000.

Okay and let s. Say let s assume you you pay cash. Pay 12000. For some insurance policy for for your business.

So so. What s our initial entry going to look like well let s say that you you do this on january 1st to fifteen. So what s what s going to happen while you re getting an asset right so you re getting prepaid insurance you re going to debit that that s an asset account you re going to debit that for twelve thousand dollars right now we re assuming here that you pay cash. So you re going to credit cash for twelve thousand dollars.

But then your boss says. Let s say it s let s say. It s the end of the month. It s a january thirty first two thousand two thousand fifteen and your boss says look i want you to go ahead.

And i want you to make some adjusting journal entries. We re going to put together an adjusted trial balance and we need to make some changes. So now you have to say okay look. We bought a 12 month policy right now we see that one month has gone by so well what s one way of thinking about that well one way to think about it is we ve used up 1 12 of our asset right this.

12000 asset is not really a 12000. Asset anymore now we should multiply it by this 1 12. All right and say okay how much of this asset have we used up right so. Ultimately we re going to say okay.

Well we ve got this 12000..

Divided by the 12 months right so 12 odd so that tells you this is 1000. A month is the rate at which we use up this asset now what happens. When you use up an asset. Well.

You say you have an expense right and in this case. We re call it insurance expense right because we ve we ve used up this insurance. Asset an insurance expense is going to be 1000. Right just that thousand a month it s been one month so that s pretty simple now what do we credit right because we need to make this balance well we re going to credit prepaid insurance right because we can t keep that asset on the books at.

12000 anymore because we know it s not worth. 12000 now it s worth 11000. So what do we have to do we have to deduct 1004. We have to credit this asset in crediting.

An asset reduces the asset so we credited for a thousand. So so now we ve we ve made an adjusting journal entry to reflect the fact that we ve basically we ve used up some of our policy. Some of our 12 month policy. We ve used up one month and now we ve adjusted for that fact at the end of the month.

Okay so so that s the type of when we re talking about a prepayment. We re looking at a prepaid expense right. But also you can have kind of this prepayment issue with unearned revenue now if you re not quite. Sure what unearned revenue is i ll just briefly explain here you re going to i meant to have example not exp.

So for this example. We re going to do unearned revenue and unearned revenue is basically the customer has sent you some money. But you haven t actually done that the act in question that would entitle you to recognize this as revenue. We have another video on revenue recognition so you can watch that if you re not quite sure what i mean.

But let me give you an example that ll make it a little bit easier to understand so..

This unearned revenue. Let s say that you sell a two year magazine subscription to one of your customers to your magazine subscription now what happens. When you have a magazine subscription well the customer typically sends you the money upfront so let s say that in this case. It s two hundred and forty dollars right so the customer sends the money upfront and now what you have is you have this money that s two hundred forty dollars.

But you haven t delivered the magazines yet so it s not revenue yet but you got the cash. So now we need to make an entry to reflect this and then i ll show you what the adjusting entry would be as time goes on so let s say that this is january 1st. 2016. Is when you sell this policy okay so what you is going to happen is you re getting cash of two hundred and forty dollars right.

That s pretty simple to figure out and then we re going to match that with this unearned revenue. That s going to make this balance this unearned revenue. Two hundred and forty dollars. It s not earned yet because you haven t delivered the magazine s yet right so now it s let s say the end of the quarter.

All right so. It s it s three and so it s march 31st. 2016. And and your boss says look let s say the end of the quarter and and now we have to go ahead and we have to make some kind of entry to reflect the fact that now three months have gone by and let s and this was a two year subscription.

So that s 24 months so three of those 24 months have gone by so now we have delivered three months of magazines and now we can go ahead and start recognizing that some of this unearned revenue has become earned and now we re coming out with our quarterly report and we want to go ahead. And we want to make an adjusted journal entry to reflect this three months that that s happened here okay. So what we re going to do is we re going to say okay look there s 24 months right two years times. Twelve months in a year.

So we re looking at 24 months and ultimately. This is a 240 subscription. So we can just say okay well what if 240 divided by 24 months right so that s going to be 10 a month that s ultimately what we recognize every month. But what s happened here we ve got three months that have gone by this isn t just one month.

So we recognize this at a rate of 10 a month..

But we haven t recognized it yet and it s been three months. So we multiply the ten a month. Right times three and that gives us that we that we need to make an adjustment for 30 right. So.

How do we do that well we need to say okay look. 30 of this this unearned revenue has now been earned so we re going to say well we need to reduce unearned revenue. We need to make an adjusting journal entry. This isn t just internal entry here we re reducing unearned revenue by 30 right.

It s now we credit revenue. Because we ve earned this of 30. So what we re basically doing is saying okay look so let s assume that we had let s say just say we had a t account for unearned revenue. All right so we have this t account.

It s a liability. So it has a credit balance. So the beginning balance before we made the adjusting journal entry here before we did that the unearned revenue would have had a balance of 240 right. But we made this adjusting journal entry here to reflect the fact that time has gone by right time time is passing by and now we ve recorded this as revenue.

Because we ve delivered 3 3. Months worth of magazines. So now we go and we say ok well now we re going to adjust this unearned revenue account right we re going to we re going to have a debit to it of 30 and then now it s going to be if we had our adjusted trial balance right so you start with a trial balance that would have the 240 will be on the trial balance. But now we make the adjusting journal entry over here.

And then we ve got the adjusted trial balance would show 210 in unearned. ” ..

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