© 2015 Cengage Learning. All Rights Reserved. Learning Objectives © 2015 Cengage Learning. All Rights Reserved. LO2 Journalize adjusting and reversing entries for prepaid expenses. LO3 Compare and contrast prepaid expense accounting procedures. LESSON8-2 Prepaid Expenses

© 2015 Cengage Learning. All Rights Reserved. Description of Prepaid Expenses ●Cash paid for an expense in one fiscal period that is not used until a later period is called a prepaid expense. ●Prepaid expenses include items such as supplies, insurance, and advertising. ●Following the concept of Matching Expenses with Revenue, only that portion of cash payment for expenses that have been used in the current fiscal period should be reported as an expense in that fiscal period. SLIDE 2 Lesson 8-2 LO2 © 2015 Cengage Learning. All Rights Reserved.

Description of Prepaid Expenses ●Prepaid expenses can be assets or expenses when initially recorded. ●The following example shows the initial recording as an expense – Supplies Expense Debit and Cash or Accounts Payable Credit. ●Prepaid expenses remain assets until they are actually used. SLIDE 3 Lesson 8-2 LO2 © 2015 Cengage Learning. All Rights Reserved.

Adjusting Entry for Supplies Initially Recorded as an Expense SLIDE 4 Lesson 8-2 LO2 © 2015 Cengage Learning. All Rights Reserved. On December 31, Vaughn takes a physical count of the supplies on hand. It determines that the supplies ending inventory is $ The $4, debit balance of Supplies Expense represents the amount of the beginning supplies inventory plus the total amount of all supplies bought during the fiscal period.

© 2015 Cengage Learning. All Rights Reserved. Closing Entry for Supplies Expense SLIDE 5 Lesson 8-2 LO2 © 2015 Cengage Learning. All Rights Reserved. The debit balance of $ in Supplies represents the amount of supplies on hand on December 31. To prepare a general ledger for the next fiscal period, closing entries are journalized and posted. After the closing entry is recorded, the Supplies Expense account balance is zero. To prepare a general ledger for the next fiscal period, closing entries are journalized and posted. After the closing entry is recorded, the Supplies Expense account balance is zero.

© 2015 Cengage Learning. All Rights Reserved. Reversing Entry for Supplies Initially Recorded as an Expense SLIDE 6 Lesson 8-2 LO2 © 2015 Cengage Learning. All Rights Reserved. An entry made at the beginning of one fiscal period to reverse an adjusting entry made in the previous fiscal period is called a reversing entry. A reversing entry is the exact opposite of the related adjusting entry. An entry made at the beginning of one fiscal period to reverse an adjusting entry made in the previous fiscal period is called a reversing entry. A reversing entry is the exact opposite of the related adjusting entry. To prepare the general ledger accounts for the next year, the $ should be returned as a debit in Supplies Expense. To prepare the general ledger accounts for the next year, the $ should be returned as a debit in Supplies Expense. RULE FOR WHEN TO REVERSE: If an adjusting entry creates a balance in an asset or a liability account, the adjusting entry is reversed.

© 2015 Cengage Learning. All Rights Reserved. Advertising Initially Recorded as an Asset SLIDE 7 Lesson 8-2 LO2 © 2015 Cengage Learning. All Rights Reserved. After recording the adjustment, the new balance of Prepaid Advertising, $35,000, is the value of the endorsement contract to be received in future fiscal years. Vaughn expenses a celebrity endorsement contract of $100,000 evenly over four years. An adjusting entry of $25, ($100, ÷ 4 years) is necessary to account for the advertising expense incurred during the current fiscal year.

© 2015 Cengage Learning. All Rights Reserved. Closing Entry for Prepaid Advertising SLIDE 8 Lesson 8-2 LO2 © 2015 Cengage Learning. All Rights Reserved. The adjusting entry did not create a balance in an asset account. Therefore, no reversing entry is required. The adjusting entry did not create a balance in an asset account. Therefore, no reversing entry is required. To prepare a general ledger for the next fiscal period, closing entries are journalized and posted. After the closing entry is recorded, the Advertising Expense account balance is zero. To prepare a general ledger for the next fiscal period, closing entries are journalized and posted. After the closing entry is recorded, the Advertising Expense account balance is zero.

© 2015 Cengage Learning. All Rights Reserved. Comparison of Prepaid Expense Accounting Procedures SLIDE 9 LO3 Lesson 8-2 © 2015 Cengage Learning. All Rights Reserved. A business can elect to initially record a prepaid expense as an asset or as an expense. Both procedures require that the account balances be adjusted before financial statements are prepared. A business can elect to initially record a prepaid expense as an asset or as an expense. Both procedures require that the account balances be adjusted before financial statements are prepared.

© 2015 Cengage Learning. All Rights Reserved. Lesson 8-2 Audit Your Understanding 1.Which accounting concept is being applied when an adjusting entry is recorded for prepaid expenses? SLIDE 10 ANSWER Matching Expenses with Revenue. Lesson 8-2 © 2015 Cengage Learning. All Rights Reserved.

Lesson 8-2 Audit Your Understanding 2.Why is an adjusting entry made for supplies at the end of a fiscal period? SLIDE 11 ANSWER To record the amount of supplies used during the period as an expense. Lesson 8-2 © 2015 Cengage Learning. All Rights Reserved.

Lesson 8-2 Audit Your Understanding 3.What rule of thumb can accountants follow to determine whether a reversing entry is needed? SLIDE 12 ANSWER If an adjusting entry creates a balance in an asset or liability account, the adjusting entry is reversed. Lesson 8-2 © 2015 Cengage Learning. All Rights Reserved.

Lesson 8-2 Audit Your Understanding 4. How does the procedure used to account for prepaid expenses affect the balance reported in the financial statements? SLIDE 13 ANSWER The balance of the prepaid expense and related expense accounts should be the same, regardless of the procedure used. Lesson 8-2 © 2015 Cengage Learning. All Rights Reserved.

Lesson 8-2 Audit Your Understanding 5. Identify the similarities and differences between the adjusting, closing, and reversing entries of the two methods used to account for prepaid expenses. SLIDE 14 ANSWER Similarities: The ending balances in the asset and related expense accounts are identical. The closing entries are identical. Differences: The amounts of the adjusting entries are different. The debit and credit accounts of the adjusting entries are reversed. Only the procedure that initially debits prepaid expenses to an expense account requires a reversing entry. Lesson 8-2 © 2015 Cengage Learning. All Rights Reserved.