A prepayment is an expense or income that is paid or earned in advance of the delivery of goods or services. Expenses paid in advance are known as prepaid expenses and may include items such as insurance premiums, rent and office supplies as well as telephone, electricity and water bills. Money earned in advance by the business after customers submit advance payments is known as prepaid earnings. A prepayment schedule summarises the order and priority in which the business makes or receives advance payments for a given number of transactions. The schedule is used in making spending decisions and forecasting future spending requirements in the managerial accounting process.
- Skill level:
Use a spreadsheet to create a journal voucher with columns labelled "Supplier Name," "Prepaid Expenses Item," Description of Transaction," "Date of Prepayment," "Prepaid Expense Amount," Debit Column," "Credit Column," and "Follow Up Comments."
List the items prepaid in the journal voucher, recording the whole prepaid amount in the journal and then distributing it into the specific months or quarters to be covered by the prepayment expense. Debit the asset account and credit cash account when the cash is paid. Make an adjusting entry by crediting the asset account and debiting the prepaid expenses account once the product or service is delivered.
Transfer the prepaid expenses to the balance sheet. Prepaid expense is treated as an asset and transferred to the expense and revenue account. You will continue to make adjusting entries each month or quarter for the period covered by the prepayment expense.
Use a spreadsheet to create a journal voucher with columns labelled "Customer Name," "Prepaid Earnings Item," Description of Transaction," "Date of Prepayment," "Prepaid Earnings Amount," Debit Column," "Credit Column," and "Follow Up Comments."
List the customers who prepaid in the journal voucher, recording their whole prepaid amounts in the journal and then distributing them into the specific months or quarters to be covered by the prepaid earnings. Credit a liability account and debit a cash account when the cash is received. Post an adjusting entry debiting the liability account and crediting the revenue account once you render the service so as to realise the revenue.
Transfer the prepaid earnings to the balance sheet and treat them as a liability. Earned revenue is transferred to the expense and revenue account. You will continue to make adjusting entries each month for the period covered by the prepaid income.
Tips and warnings
- You can make prepayment of accruing liabilities like loans to reduce interest expenses to be incurred on the amount that is prepaid.
- Always provide vivid descriptions of all the prepayment transactions to facilitate easy interpretation by members of the organisation's management.
- Do not recognise any prepaid revenue as realised revenue prior to the period of product or services delivery and after the actual delivery of the products because such an action would amount to non-procedural conversion of the business liabilities into assets.
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