Insurance by months, rent by months, supplies by the count

◈ 10 cards

Adjust a prepaid expense by time and supplies by a physical count, and handle the alternative where the payment was first booked as an expense.

Time-based prepaids

A prepaid bought for a stated period expires evenly with time. The adjustment moves the portion used out of the asset:

$Expense for the period = Amount paid \times \frac{months used}{months bought}$

Worked example — Northlake's insurance

On 3 December Northlake paid $6,000 for twelve months of cover from 1 December. At 31 December one month has been used: $6{,}000 \times \tfrac{1}{12} = 500$.

Dec 31  Insurance Expense                   500
            Prepaid Insurance                         500
        One month of the twelve-month policy expired.

After posting, Prepaid Insurance shows $6, 000 - 500 = 5, 500$ — eleven months of cover still owned, the unexpired portion, and that is the balance-sheet figure. The income statement shows 500. The two numbers always add back to what was paid.

Pinecrest's rent. Pinecrest paid $7,200 on 1 October for six months' rent. At 31 December three of the six months are used: $7{,}200 \times \tfrac{3}{6} = 3{,}600$. Dr Rent Expense 3,600 / Cr Prepaid Rent 3,600; Prepaid Rent is left at 3,600 for January to March.

Supplies — by the count

Supplies are not used evenly, so nobody tracks each pencil; instead the year-end count gives what is left, and the adjustment is what is gone:

$Supplies used = Opening + Purchases - On hand at the count$

Northlake's café supplies: opening 4,200 (from November) plus 3,100 bought on 4 December = 7,300 available. The 31 December count finds 2,150 on hand. So $7, 300 - 2, 150 = 5, 150$ was used.

Dec 31  Supplies Expense                  5,150
            Supplies                                5,150
        Supplies used; 2,150 on hand per count.

The Supplies account is left at 2,150 — the count. The mark-losing error is to credit Supplies for the 2,150: that treats what is left as if it were what was used, and leaves the asset at 5,150 of supplies that do not exist.

The alternative first recording

Some bookkeepers debit the expense on the day a prepaid is paid — not wrong, just a different starting point, and the adjustment then runs the other way. Harrowgate Landscaping Ltd. bought a $2,400 one-year policy on 1 September and debited the whole amount to Insurance Expense. At 31 December four months have expired (800) and eight months, 1,600, have not. Insurance Expense is holding 2,400 and should hold 800; Prepaid Insurance is holding nothing and should hold 1,600. The adjustment moves the unexpired portion out of the expense into the asset:

Dec 31  Prepaid Insurance                 1,600
            Insurance Expense                       1,600
        Eight months of the policy unexpired at year end.

Either starting point ends in the same place — Insurance Expense 800, Prepaid Insurance 1,600 — which is the check: after the adjustment, the balance-sheet account shows the unexpired portion and the income-statement account shows the expired portion, whichever account the payment was first booked to.