Prepaid Expense Journal Entry

Overview

Prepaid expense is the payment that the company makes in advance for the expense that will incur through the passage of time or through the consumption. Likewise, the company needs to account for any prepaid expense with the proper journal entry to avoid misstatement that could occur on financial statements due to inappropriate recognition.

Under the accrual basis of accounting, expense should be recognized when it incurs, not when the payment is made. Hence, when the company makes an advance payment, the prepaid expense journal entry will involve the balance sheet items only. In this case, the expense will incur at a later date when the prepaid expense becomes the expired cost through the consumption or through the passage of time.

Prepaid expense journal entry

The company can make prepaid expense journal entry by debiting prepaid expense account and crediting cash account.

Account	Debit	Credit
Prepaid expense	000
Cash		000

In this journal entry, both the prepaid expense account and cash account are current assets on the balance sheet. Likewise, this journal entry does not affect the income statement as the expense has not incurred yet. What it does is simply increasing one asset (prepaid expense) and decreasing another (cash).

After the expense has incurred, the company can make the journal entry to recognize it by debiting the expense account and crediting the prepaid expense account.

Account	Debit	Credit
Expense	000
Prepaid expense		000

This journal entry is made to record the expense incurred during the period as well as to eliminate the prepaid expense in the amount that it has been used or expired. Likewise, the unused or unexpired portion of prepaid expenses will remain on the balance sheet.

Example

For example, on June 15, 2020, the company ABC Ltd. bought $5,000 of office supplies. The company has a policy to recognize office supplies as prepaid expenses in the current assets due to the amount is considered significant.

1. What is the journal entry on June 15, 2020?

The beginning balance of office supplies was $3,000 and after counting at the end of the period, the ending balance was determined to be $4,500. The company purchased only $5,000 of office supplies during the period.

2. What is the journal entry at the period end adjusting entry for the prepaid expense adjustment of office supplies?

Solution:

1. On June 15, 2020

ABC Ltd. can make the prepaid expense journal entry for office supplies on June 15, 2020, as below:

Account	Debit	Credit
Supplies	5,000
Cash		5,000

In this journal entry, the supplies account is a prepaid expense that will be recognized as an expense when it is used. Likewise, the $5,000 is recorded as a prepaid expense in the current asset of the balance sheet. Hence, there is no impact on the income statement as the expense has not incurred yet.

2. At period end adjusting entry

At the end of the period, after the company ABC Ltd. counts the supplies on hand, it can record the used-up supplies as expenses.  

Used-up supplies = 3,000 + 5,000 – 4,500 = $3,500

In this case, the company can make the journal entry for prepaid expense adjustment of office supplies as below:

Account	Debit	Credit
Supplies expense	3,500
Supplies		3,500

In this journal entry, although ABC Ltd. bought $5,000 of supplies during the period, it recognized only $3,500 as supplies expense. This is due to, after determining the supplies on hand, it shows that the company has used up only $3,500 of the office supplies during the period.