Sometimes ago, I have write about how to prepare balance sheet in tally. If you read my old post, then you will know about some basics of accountancy which as accountant you must know. Accounting of journal entry of prepaid expenses is a must for preparation and finalisation of accounting statemetns as well as to ascertain the actual profit/loss during the time by the entity
Proper accounting of prepaid expenses is such a basic accounting feature which an accountant must know and understand the same. So you must know what expenses can be determined as prepaid expenses for journal entry purpose.
In a computerize accounting software like tally, preparing a balance sheet is not as easy as ABC or just pressing certain keys of the key board. However it will be a half prepared balance sheet as an accountant is required to pass several journal entry before he generate a perfect balance sheet.
in my previous post onhow to prepare a balance sheet, I have covered several journal entry that is required to be passed in the books of account. Today I will explain one more such journal entry that is required to be pass for finalization of books of account. This journal entry is relating to prepaid expenses.
What is pre paid expenses?
As the name suggest, it is an expenses which is paid in advance and mostly these expenses are relating to Insurance expenses. A prepaid expenses is calculated and decided on the base of the period covered by that expenses and period covered by the books of account.
Let me explain you with example
A company paid insurance premium on plant and machinery for Rs. 1,00,000 as date 1st June 2009. Now check the period of the policy document. The period is stipulated by the insurance policy is starting from 1st June 2009 to 31st May, 2010.
Now as per the Income tax Rules, books of accounts are required to be prepared as per financial year e.g. from 1st April to 31st March.
So, in the above example Insurance premium pertaining to the period 1st June to 31st March, 2010 only will be accounted in the books of account for the FY 2009010 (In other words it will be debited to profit and loss account) and the balance insurance expenses for the month of April 2010 and May 2010 should be debited to the profit and loss account of the FY 2010-11
So, in the FY 2009-10 two months insurance premium will be shown as advance payment of expenses (Pre paid Expenses under the group loans and advances or current assets) and on the first day of the next year (FY 2010-11 in this case) prepaid insurance expenses entry which was made on 31st March, 2009 is required to be reversed.
to calculate prepaid insurance in the above example, divide entire expenses of Rs.1,00,000 by 12 months it will come out 8333. now multiply it with 2 months period that is relating to next Financial year and will be accounted as pre paid expenses
Now, Let’s see how to pass this entries in the books of account,
HOW TO PASS JOURNAL ENTRY FOR PREPAID EXPENSES
When the insurance premium of Rs. 1,00,000 paid as on 1st June, 2009 the entry will be made as per below :
Dr. Insurance premium Rs. 100,000.00
Cr. Bank account Rs.100000.00
(Being amount paid towards Insurance premium for the period…… vide policy number…..)
On 31st March 2009, prepaid expense journal entry will be passed as per below for the above expenses
Dr. Prepaid Expenses Rs. 16,667.00
Cr. Insurance premium Rs. 16,667.00
(Being two months insurance premium transfer to prepaid expenses account)
On 1st April,2010, the above entry will be reversed in the books of account by Dr. Insurance premium and crediting Prepaid Expenses with the same amount i.e. Rs. 16,667.00
EXPENSES WHICH REQUIRES TO BE PASS AS PREPAID
As explained above, any expenses paid in advance as on date of closure of books of account is to be treated as pre paid expenses. Generally following types of transactions are to be looked for prepaid expenses and for this purpose the period covered by the expenses is very important to determine whether an expenses consist a portion of the pre paid expenses
If you need further explanation, then don’t hesitate to drop your comment here.