On July 1 Of The Current Calendar Year, Olive Company Paid $7,500 Cash For Management Services To Be Performed Over A Two-Year Period Beginning July 1. Olive Follows A Policy Of Recording All Prepaid Expenses To Assets Accounts At The Time Of Cash Payment. The Adjusting Entry On December 31 Of The Current Year For Olive Would Include:

On July 1 Of The Current Calendar Year, Olive Company Paid $7,500 Cash For Management Services To Be Performed Over A Two-Year Period Beginning July 1. Olive Follows A Policy Of Recording All Prepaid Expenses To Assets Accounts At The Time Of Cash Payment. The Adjusting Entry On December 31 Of The Current Year For Olive Would Include: A. A debit to a prepaid expense and a credit to an expense for $1,875. B. A debit to an expense and a credit to a prepaid expense for $1,875. C. A credit to a liability and a debit to a prepaid expense for $1,875. D. A debit to an expense and a credit to a prepaid expense for $5,625. E. A debit to a prepaid expense and a credit to Cash for $5,625.
Initially, On July 1 of the current calendar year, when the Olive Company paid cash for management services, it is recorded as a Prepaid Expense (Management Fee Paid In Advance) and as an asset as it is the company’s policy to do so. The journal entry to management fee paid in advance is shown below:

          Prepaid Expense a/c / Management Fee Paid In Advance a/c $7,500

                                                                                                             Cash a/c $7,500

                               (Expense Paid In Advance For Two Year Management Services)

Calculation Of Expired Portion Of Prepaid Expense (PE)

PE for 2 year = $7,500

PE for 1 year = $7,500 / 2 = $3,750

PE for 1 Month =$3,750 / 12 = $312.5

PE for half year (6 Months) = $3,750 / 2 = 1,875 Or $312.5 X 6 = $1,875 (From July 1 To 31st December of the current calendar year)

On 31st December of this current calendar year, the adjusting entry to record is shown below:

            Expense a/c / Management Fee Exp. a/c 1,875

                                                                             PE. a/c / Management Fee Paid In Advance a/c $1,875

                                            (Expired Portion Of Prepaid Exp. Is Expensed)

The expired portion of $1,875 represents an expense which is transferred to Income Statement of the current calendar year. The unexpired portion of $5,625 is recorded on balance sheet as a current asset on asset side of balance sheet.

After transferring the expired portion to expense account, the remaining unexpired portion is 7,500 - 1,875 = $5,625, which is to be expired after one and half year (equal to 18 months). After that, the management fee paid in advance account is closed out as at that time, the Olive Company has fully received its management services against the payment of $7,500.

Therefore, the correct option of this multiple choice question (mcq) is A. The options B, C, D and E options of this mcq are incorrect choices here.

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