2 Methods of Prepaid Expenses For Accounting Treatment

There are two methods of recording Prepaid Expenses in Accounting. Both are explained below:

1. When Prepaid Expenses Initially Recorded as An Expense / Prepaid Expenses Income Statement Approach

2. When Prepaid Expenses Initially Recorded as Current Asset / Prepaid Expenses Balance Sheet Approach

1. Under first method, we initially recorded prepaid expenses as an Expense and debit the relevant expenses account such as Rent Expense Account and credit the cash account. At the end of accounting period, the portion of that expense (Rent) that is related to next year or still not expired or against which still benefits are not received is transferred to Prepaid Expense Account (Prepaid Rent Here) as a Current Asset on Balance Sheet.

For Example, If we paid rent of Rs. 60000 (Rs. 5000 Per Month) as Prepaid Rent or makes advance payment to tenant company for 12 months on 1^st April, 2017, then we initially records it as an Rent Expense by recording following Journal Entry:

                                                         Rent Expense a/c    60000

                                                                                    Cash a/c   60000

(Rent Paid For Cash)

At the end of accounting period ending on 31^st December, 2018, the portion of rent expense against which we still not received the benefit is transferred to Prepaid Rent or Rent Paid In Advance account by passing following Adjusting Entry as shown below:

                                                  Prepaid Rent a/c    10000

                                                                            Rent Expense a/c   10000

(Rent Prepaid at the end of Accounting Period)

Rent for 10 Month From 1^st April To 31^st December against which the services are received is 5000 X 10 = Rs. 50000

So, Prepaid Rent = 2 X 5000 = Rs. 10000 or 60000 - 50000 = Rs. 10000 and will be shown on Balance Sheet while Rent Expense = Rs. 50000 will be recorded in Income Statement / Profit And Loss Account.

2. Under the second Method, we initially record the Prepaid Expenses as a Current Asset by debiting it and crediting Cash account. At the end of accounting period, we separate the portion of that Prepaid Expense that includes both Expense And Prepaid Expense and transferred that Expense portion to Income Statement against which benefits are received by the businesses. We can do so by debiting relevant expense accounts (e.g. Rent Expense) and crediting Prepaid Expense account (Prepaid Rent Here). The remaining amount of Prepaid Expense will go to Balance Sheet.

Taking our above example, if we paid rent for 12 months in advance, then by considering this case, we pass following adjusting entry:

                                                       Prepaid Rent a/c    60000

                                                                                  Cash a/c   60000

(Rent Paid In Advance)

At the end of accounting period (i.e., 31^st December), the portion of Rent Expense is transferred to Rent Expense and remaining portion is still remained with Prepaid Rent and shown on Balance Sheet as shown below:

                                               Rent Expense a/c     50000

                                                                             Prepaid Rent a/c   50000

(Benefits Against Rent Expense is Received)

The remaining amount of Prepaid Expense (60000 - 50000) Rs. 10000 goes to Balance Sheet.

The Rent Expense of Rs. 50000 will be recorded in Income Statement for the period.

You can see under both methods, the results are the same. In both cases, Rent Expense and Prepaid are the same although they are presented differently on Accounting Records.