Prepaid expenses before transactions when cash is paid

Expert Solution

It is helpful to group adjustments by the timing of the cash receipt or cash payment in relation to the recognition of the related revenues or expenses. Sometimes, the company pays cash before the expense is recognized or receives cash before the revenue is recognized. Sometimes, the company pays cash after the expense is recognized or receivescash after the revenue is recognized.

When the cash changes hands beforehand, two types of adjustments result:

Prepaid expenses, which reflect transactions when cash is paid before the related expense is recognized.

Unearned revenues, which reflect transactions when cash is received before the related revenue is recognized.

Prepayments are also called deferrals because the recognition of an expense (or revenue) is deferred (or postponed) until after the related cash is paid (or received).When the cash changes hands afterwards, two other types of adjustments result:

Accrued expenses, which reflect transactions when cash is paid after the related expense is recognized.

Accrued revenues, which reflect transactions when cash is received after the related revenue is recognized.

Adjusting entries are necessary so that revenues, expenses, assets, and liabilities are correctly reported.

Specifically, an adjusting entry is made at the end of an accounting period to reflect a transaction or event that is not yet recorded. Each adjusting entry affects an income statement account and a balance sheet account.

As a result, every adjusting entry must either debit an expense account or credit a revenue account. As such, start the process by deciding whether an expense has been incurred or a revenue has been earned.

Adjusting entries do not affect the Cash account. Transactions affecting the Cash account are external transactions that are recorded during the accounting period. Because transactions affecting Cash have already been recorded, no related adjustments are required.

ekkarill92 answered 2 years ago

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