Prepaid Assets

Making payment upfront

Prepaid Asset accounts are used for upfront purchases utilized over a span of time.

These work pretty much the exact same!

  • Prepaid Rent
  • Prepaid Insurance

We'll learn how to work with Prepaid Assets with Prepaid Rent. Keep in mind: This would work the same way with Prepaid Insurance.

Scenario: On March 1st, you begin renting out a warehouse space to mass-produce your lemonade. As a part of the rental agreement, you pay for 3 months of rent upfront. Each month of rent costs $1,000.

The blue underlined text signals...

  • We are paying for rent upfront, before we actually use the rental property and incur the rental expense. ➡️ We'll represent this through Prepaid Rent.
  • We're paying for this rent right now. ➡️ We'll pull the money for payment out of Cash.

Monthly Rent = $1,000
Months = 3

Prepaid Rent = 3 x $1,000
Prepaid Rent = $3,000

TransactionDebitCredit
Prepaid Rent$3,000
     ??????

The reason is...

  • We have paid in advance (+) for 3 months of rent.
  • This is represented through Prepaid Rent.
  • Which is an asset account, and therefore has a normal debit balance.
  • So, to increase it by $3,000, we'll debit it.
TransactionDebitCredit
Prepaid Rent$3,000
     Cash$3,000

The reason is...

  • We have spent (-) cash for those 3 months of rent.
  • This is represented through Cash.
  • Which is an asset account, and therefore has a normal debit balance.
  • So, to decrease it by $3,000, we'll credit it.

Adjusting entry

Scenario: On March 31st, you owe one month of rent. Each month of rent costs $1,000. Write the adjusting entry for March's rent.

The blue underlined text signals...

  • Write the adjusting entry for March's rent. ➡️ We're going to be adjusting the balance of our Prepaid Rent account.
  • We have used the rental property for one month. ➡️ We'll expense this through Rent Expense.

Rent = $1,000

TransactionDebitCredit
??????
     Prepaid Rent$1,000

The reason is...

  • We are now "cashing-in" (-) on 1 of those 3 months of rent we paid upfront for.
  • This is represented through Prepaid Rent.
  • Which is an asset account, and therefore has a normal debit balance.
  • So, to decrease it by $1,000, we'll credit it.
TransactionDebitCredit
Rent Expense$1,000
     Prepaid Rent$1,000

The reason is...

  • We have incurred an expense (+) for utilizing the property as a cost of running our business through rent.
  • This is represented through Rent Expense.
  • Which is an expense account, and therefore has a normal debit balance.
  • So, to increase it by $1,000, we'll debit it.

ACCRUAL BASIS REMINDER: Even though we paid upfront for this rent, the action of utilizing the warehouse occurred in this current period (March). Therefore, we must record it now to follow accrual basis accounting!

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