Prepaid Expenses- Partnership Adjustments Part 6

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Introduction

In this article we will learn about the adjustment for Prepaid expenses in partnership accounts.

Please note that the adjustment will be done in a similar manner whether you are doing admission, retirement, death or change in profit ratio question. You need not understand the adjustments separately for these chapters.

Meaning of prepaid Expenses

Prepaid expenses means expenses,
- which have not yet become due for payment,
- but are already paid in advance.
Any expenses which we pay in cash or bank, and enter in profit and loss account debit side, can be prepaid if these are paid before due date. Few examples are Rent, Salary, Electricity, Repairs, advertisement, insurance.

graph LR A[Expenses] --> B[Not yet become due] A --> C[Already paid in advance] style A fill:#f9f,stroke:#333 style B fill:#ccf,stroke:#333 style C fill:#f96,stroke:#333 classDef default stroke:#333,fill:#fff;

Example of Prepaid Salary

Suppose in my firm I pay salary to all employees on the last date of the month. So every month I will pay salary lets say on 30th April or 30th September or 31st January etc.

Suppose in the month of September, some employees come to me, and say, that they want urgent money, and they want this month salary in advance. I pay them salary on 10th September itself for the whole month of September. This is known as prepaid salary.

Example of Prepaid Electricity Expenses

Suppose due date for paying electricity bill every month is 25th.

If I pay the bill, before that date, it will be called prepaid electricity Expenses.

How Prepaid expenses adjustment given in the question

Advertisement expenses of Rs 1200 are to be carried forward as prepaid expenses
Out of insurance premium debited to profit and loss account, Rs 1200 be carried forward as prepaid insurance
Salary paid in advance Rs 1200
Rs 1200 rent was paid in advance to the landlord to be carried forward

Please note that what whatever the language in question is, the adjustment will be done in similar manner. Let's understand how to do this adjustment.

Understand prepaid expenses adjustment

Prepaid expense is an asset. Debit and Credit rules for assets will apply. So increase in prepaid expenses gets debited, and decrease in prepaid expenses gets credited.

It is a payment made in advance for which we now have to pass an entry in books of accounts. By mistake earlier we made the entry in the normal expense account. We will reverse the expenses entry made earlier and transfer it to prepaid expenses account which is an asset

The assets of the firm will increase due to this entry.

Since the Book Value of asset will increase so there will be Revaluation Gain. Another way to understand is , we are reversing the expenses entry passed earlier. This will reduce expenses in books of account and hence there will be revaluation gain.

graph LR A[Incorrect Expense Entry] -->|Reverse| B[Prepaid Expenses Account] B -->|Is an| C[Asset] C -->|Increase| D[Book Value] D -->|Increase| E[Revaluation Gain] A[Incorrect Expense Entry] -->|Reverse| F[Expenses Booked Earlier] F[Expenses Booked Earlier] --> E[Revaluation Gain] style A fill:#ffcccc,stroke:#333 style B fill:#ccffcc,stroke:#333 style C fill:#cce6ff,stroke:#333 style D fill:#ffe6cc,stroke:#333 style E fill:#e6ccff,stroke:#333 classDef default stroke:#333,fill:#fff;

Prepaid Expenses Journal Entry

Prepaid Expense A/c Dr.. Rs 2000
- To Revaluation A/c Rs 2000

Prepaid Expenses is an asset which is increasing, so it gets debited. In case of increase in assets we have a profit, so revaluation account gets credited.

Another reason for revaluation profit is that earlier by mistake we recorded prepaid expense which is an asset as normal expense in profit and loss account. Now we are reversing that incorrect expense and so revaluation profit will increase.

Prepaid Expenses in Revaluation Account

Particulars	Amount	Particulars	Amount
		By Prepaid Expense A/c	1200

Since there is a profit, so it will be shown on credit side of revaluation account.

There will be no entry on the debit side of revaluation account

Remember in examination question replace the word "expense" by the type of expense like rent, salary, etc as given in the question.

Prepaid Expenses in Partner Capital A/c

Particulars	A	B	Particulars	A	B

There will be no impact in partner capital account as we have not passed any entry in partner capital account

Prepaid Expenses in Balance Sheet

Liabilities	Amount	Assets	Amount
		Prepaid Expense	+1200

In the balance sheet the value of assets will be increased. In our example on the assets side we will write prepaid expenses Rs 1200. Remember in examination question replace the word "expense" by the type of expense like rent, salary, etc as given in the question.

Finally

Here is the summary of the whole Prepaid Expenses adjustment.

graph LR A[Prepaid Expenses Adjustment] -->B[Revaluation Account]--> C[Credit Side] A[Prepaid Expenses Adjustment] -->D[Partner Capital Account]--> E[No Impact] A[Prepaid Expenses Adjustment] -->F[Balance Sheet]--> G[Write on Assets Side] classDef default stroke:#333,fill:#fff;

That's all for this adjustment. Please go through below links for more partnership accounts adjustments on reconstitution.

Partnership Accounts Index