Section 5 - Deferred (Prepaid) Expenses

Question 1

Your company buys office supplies and debits Supplies on Hand for $34,000. At year end, the company estimated $6,000 supplies left on hand. The adjusting entry will leave an ending balance in Supplies expense of ____ and an ending balance in Supplies on Hand of _____

Answer 1

Supplies Expense - $28,000, Supplies on Hand - $6,000

A debit to Insurance Expense increases the expense account balance to reflect the ending balance as the amount of expense incurred, used up or expired during the period. A credit to Prepaid Insurance decreases the prepaid asset account balance to reflect the unused portion of the prepaid expense to be used in the future after accounting for the reduction in the assets value for the period.

Question 2

If the entry to record an Insurance premium paid in advance was a debit to Prepaid Insurance, then the adjusting entry requires a debit to

Answer 2

Insurance Expense.

Transactional Entry

Prepaid Insurance (DR)

Cash (CR)

At the end of the year or period, the books must be adjusted to recognize the expense for the period and reduce the value of the prepaid asset. The adjusting journal entry would be as follows:

Insurance Expense (DR)

Prepaid Insurance (CR)

Question 3

If the transactional entry for a Deferred Expense was debited to an Expense account, failure to record the adjusting entry has the following effect - Understated / Overstated / No effect

Assets

Liabilities

Revenue

Expenses

Net Income

Answer 3

Assets - Understated

• Liabilities - No effect*
• Revenue- No effect*

Expenses - Overstated

Net Income - Understated

Question 4

An expense should only be recorded when it has been ____

Answer 4

Incurred.

Question 5

When accounting for Deferred Expenses, regardless of which account was initially debited when recording the transactional entry, the ending balances in the Expense and Prepaid Expense account will be the same.

True or False

Answer 5

True.

At the end of the period, in order to adhere to the matching principle, the Expense account enging balance must only reflect the amount of expenses incurred, used or expired for the period, and the Prepaid (Asset) Expense account balance must reflect the unused portion of the prepaid expense to be used in the future.

Question 6

Expense accounts appear on which Financial Statement?

Answer 6

Income Statement

Question 7

Expenses paid before they have been incurred are referred to as:

Answer 7

Deferred (Prepaid) Expenses or Prepaid Assets

Question 8

If the entry to record an Insurance premium paid in advance was a debit to Insurance Expense, then the adjusting entry requires a debit to

Answer 8

Prepaid Insurance.

Transactional Entry

Insurance Expense (DR)

Cash (CR)

At the end of the year or period, the books must be adjusted so the balance in the Insurance expense only reflects the amount of expense incurred, used up or expired for the period and record the unused portion of the prepaid expense in a prepaid asset account.

Adjusting Entry

Prepaid Insurance (DR)

Insurance Expense (CR)

A debit to Prepaid Insurance increases the prepaid asset account balance to reflect the unused portion of the prepaid expense to be used in the future. A credit to Insurance Expense reduces the expense account balance to reflect the ending balance as the amount of expense incurred, used up or expired during the period.

Question 9

If the transactional entry for Deferred Expenses was debited to the Prepaid (Asset) Expense account, failure to record the adjusting entry has the following effect:

Understated / Overstated / No effect

Assets

Liabilities

Revenue

Expenses

Net Income

Answer 9

Assets - Overstated

• Liabilities - No Effect*
• Revenue - No Effect*

Expenses - Understated

Net Income - Overstated

Question 10

Your company prepaid rent for 1 year in the amount of $13,200 and debited Prepaid Rent.

What adjusting journal entry should be recorded if your company’s year ends 5 months later?

Answer 10

Transactional Entry

Prepaid Rent (DR) $13,200

Cash (CR) $13,200

In order to adjust the books to recognize the expense incurred for the period and reduce the balance in the prepaid asset account, the adjusting journal entry would be as follows.

Adjusting Entry

Rent Expense (DR) $5,500

Prepaid Rent (CR) $5,500

A debit to Insurance Expense increases the expense account balance to reflect the ending balance as the amount of expense incurred, used up or expired during the period. A credit to Prepaid Insurance decreases the prepaid asset account balance to reflect the unused portion of the prepaid expense to be used in the future after accounting for the reduction in the assets value for the period.

Question 11

If the entry to record an Insurance premium paid in advance was debited to Insurance Expense, then the adjusting entry requires a credit to

Answer 11

Insurance Expense.

Transactional Entry

Insurance Expense (DR)

Cash (CR)

At the end of the year or period, the books must be adjusted to recognize the expense incurred for the period and there must be a reduction to the balance in the prepaid asset account to reflect the future benefit to the company. Therefore, the adjusting journal entry would be as follows:

Adjusting Entry

Prepaid Insurance (DR)

Insurance Expense (CR)

A debit to Prepaid Insurance increases the prepaid asset account balance to reflect the unused portion of the prepaid expense to be used in the future. A credit to Insurance Expense reduces the expense account balance to reflect the ending balance as the amount of expense incurred, used up or expired during the period.

Question 12

Your company paid rent in advance and debited the Prepaid Rent account.

If an adjusting entry is not recorded at year end, total assets on the balance sheet will be (understated/overstated/unaffected)

Answer 12

Overstated.

Failure to reduce Prepaid Rent by the amount of Rent expense incurred for the period will result in the balance of Prepaid rent, an asset, being overstated. The associated Rent expense account would be understated, thus net income for the period would be overstated.

Question 13

A company prepays insurance and debits the Insurance Expense account.

If at year-end, only a portion of the insurance has been used up, the adjusting journal entry will (reduce/increase) _____ the balance in Insurance Expense.

Answer 13

Reduce.

Question 14

If the entry to record an Insurance premium paid in advancwas debited to Prepaid Insurance.

The adjusting entry at year end requires a debit to

Answer 14

Insurance Expense.

Transactional Entry

Prepaid Insurance (DR)

Cash (CR)

In order to adjust the books to recognize the expense incurred for the period and reduce the value of the prepaid asset, the adjusting journal entry would be as follows.

Adjusting Entry

Insurance Expense (DR)

Prepaid Insurance (CR)

A debit to Insurance Expense increases the expense account balance to reflect the ending balance as the amount of expense incurred, used up or expired during the period. A credit to Prepaid Insurance decreases the prepaid asset account balance to reflect the unused portion of the prepaid expense to be used in the future after accounting for the reduction in the assets value for the period.

Question 15

Prepaid Expenses appear on which Financial Statement?

Answer 15

Balance Sheet

Question 16

Deferred Expenses are recorded on the books as a ______ until incurred, used up, or expired.

Answer 16

Asset

The portion of a prepaid expense that has not been used up and has future benefit to the company is recorded on the books as a prepaid asset until it’s value is used up in the future.

Question 17

What is the difference between Accrued and Deferred Expenses?

Answer 17

Accrued expenses have been incurred but payment has not yet been made. Ex. Verizon bill has been received for the month of June. The company records the expense on the books, however, payment will not be made until next month.

Deferred expenses are those paid in advance but the expense has not yet been incurred. Ex. A company prepays for a 12-month insurance premium on July 1. At year-end, December 31st, 6 months insurance has expired and must be recognized as an expense and the value of the prepaid asset must be reduced.

Question 18

With deferred expenses, payment takes place ______ the expense is incurred, used up or expired.

Answer 18

Before

Question 19

Expenses are booked when _____, not when ______

Answer 19

Expenses are booked when INCURRED, not when PAID.

Question 20

A company pays a two-year insurance premium in advance.

This is an example of:

Answer 20

Deferred (Prepaid) Expense which is recorded as a Prepaid Asset