Question

Explain why recording transactions as pre-paid expenses and unearned revenue are important. (Think of the greater accounting concept that is followed)

Answer 1

When an expense is paid prior to when it is due it is termed as prepaid expense. These expense are assets for us as we have already paid for what we would have required to pay in future,.

This affects our cash and therefore, it is important to record such transaction relating to pre-paid expenses.

Further, this is to balance out to accounting equation, if cash goes out, asset reduces, they must be a consequent affect to balance out the accounting equation and that will be creation of an asset namely pre-apid expense in this case.

Unearned revenues are revenues earned prior to services/products being provided. These unearned revenues are out liabilities and we have obligation to fulfill these as and when required.

When we receive cash for a service not yet provided, our cash is increasing and now to balance out the accouting equation a simultaneous affect has to be created which would be balancing the accouting equation. In this case the same will be creation of a liability namely unearned revenue.

Therefore, it is important to record these transactions.