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What is prepaid expense?

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Certain expenses like insurance premium,rent rates etc, are often paid in advance.In this case a part of the amount paid during a given period relates to a subsequent period .For example the debit in the following expense account shows the premium cost of two-year fire insurance policy.

insurance-account

In this case,We paid 12 months insurance premium, out of this 12 months , premium of three months( 5000/12 x 3 = 1250) are related to current year that is for Financial Year 2015-16 and remaining 9 months premium (5000/12 x 9=3750) is related to up coming Financial Year,That is  2016-17.

Before the books are closed at the end of 2015, the unexpired premium should be taken out of the expense account and transferred to a prepaid expense or asset account.This is accomplished by the following journal entry.

journal-for-prepaid-expense

After this entry is posted,the two accounts affected will appear as follows.

insurance-account-after-posting-prepaid-insurance

The balance in this account now shows the insurance expenses for 2015 and is debited to the profit and loss account.

prepaid-insurance-account

Prepaid Insurance account is an asset account;it represents the cost of a valuable right to collect from an insurance company in the event of a fire loss during 2016.So 3750 will be shown on the asset side of the balance sheet as on 31-03-2015.

Prepaid asset will be charged to the expense of the next year. In above case the prepaid insurance will charge to the Insurance A/c as expense and the prepaid Insurance A/c which was carried forward from last Financial year will be cancelled.

pre-paid-insurance

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