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Recording Prepaid Expenses in Expense Accounts.

We explained that prepaid expenses are assets when they are purchased and are recorded with debits to asset accounts. Adjusting entries transfer the costs that expire to expense accounts at the end of an accounting period.There is an acceptable alternative practice of recording all prepaid expenses with debits to expense accounts. If any prepaids remain unused or unexpired at the end of an accounting period, then adjusting entries must transfer the cost of the unused portions from expense accounts to prepaid expense (asset) accounts. The financial statements are identical under either procedure, but the adjusting entries are different.

To illustrate the accounting differences between these two practices, let’s look at Finlay Interiors’ cash payment for 24 months of insurance coverage beginning on January 1. Finlay Interiors recorded that payment with a debit to an asset account, but it could have been recorded as a debit to an expense account. 

We explained that prepaid expenses are assets when they are purchased and are recorded with debits to asset accounts. Adjusting entries transfer the costs that expire to expense accounts at the end of an accounting period.

There is an acceptable alternative practice of recording all prepaid expenses with debits to expense accounts. If any prepaids remain unused or unexpired at the end of an accounting period, then adjusting entries must transfer the cost of the unused portions from expense accounts to prepaid expense (asset) accounts. The financial statements are identical under either procedure, but the adjusting entries are different.

To illustrate the accounting differences between these two practices, let’s look at Finlay Interiors’ cash payment for 24 months of insurance coverage beginning on January 1. Finlay Interiors recorded that payment with a debit to an asset account, but it could have been recorded as a debit to an expense account.