Prepaid Expense Journal Entry - Explained

Companies usually makes payment of some of their expenses in advance. This is done maybe because of a policy that needs to be followed or just because the paying company want to avoid making monthly payments. An example of prepaid expense is the payment of rent for an office space to be used for the next 12 months. As a result, the lessee records prepaid expense journal entry with a prepaid expense account and the lessor will have an Unearned Income Account.

The Prepaid Expense account is an asset as to the tenants point of view is concerned. This account is credited upon expiration of the period being paid in advance. On the other hand, Unearned Income Account is a liability on the part of the landlord.

Prepaid Expense Journal Entry 

Assume: ABC Company rented an Office Space to XYZ Company to. The monthly payment for the rent is $500.00. Supposed that on January 25, 2016, ABC Company pays $1,000.00 for the rent for the month of February and March.

On January 25, the following entries were created:

ABC Company Book

Dr.     Prepaid Rent                      1,000.00

Cr.     Cash                                      1,000.00

XYZ Company Book

Dr.      Cash                                    1,000.00

Cr.      Unearned Rent Income   1,000.00

After a month, the rent for February has lapsed. Therefore, there is a need to prepare an adjusting entry to show the correct balance of prepaid rent account. The following entries were to be made: 

ABC Company Book

Dr.     Rent Expense                    500.00

Cr.     Prepaid Rent                     500.00

XYZ Company Book

Dr.     Unearned Rent Income    500.00

Cr.     Rent Income                        500.00

The balance of the Prepaid Rent Account and Unearned Rent Income Account on February 2016 will be $500.00. This is the Rent for the month of March that is still outstanding as of the end of february.

Why Do we need to have a prepaid expense journal entry?

Prepaid expense journal entry is created for advance payment of expenses. This entry is made to ensure that the accounting practice is in accordance with the generally accepted accounting principles.

These entries are corrected by preparing an adjusting entry just like we have made in the illustration. This method is done to show the amount that should have to be recorded in the books of account of the company.

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