Chapter 14A, Problem 1SEA

EXPENSE METHOD OF ACCOUNTING FOR PREPAID EXPENSES Davidson’s Food Mart paid $1,200 in advance to the local newspaper for advertisements that will appear monthly. The following entry was made:

At the end of the year, December 31, 20--, Davidson received notification that advertisements costing $800 had been run. Prepare the adjusting entry.

To determine

Prepare the adjusting entry.

Explanation of Solution

The expense method of accounting for prepaid expenses:

In expense method of accounting for prepaid supplies, prepaid expenses and other prepaid items are recorded as purchases during its purchase.

Adjustment entries:

Adjusting entries are those entries which are made at the end of the year to update all the balances in the financial statements to show the true financial information and to maintain the records according to accrual basis principle.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

Record the adjusting entries under prepaid expenses method:

Date	Account titles and Explanation	Debit ($)	Credit ($)
December 31	Prepaid advertising $(\$1,200-\$800)$	400
	Advertising expense		400
	(To record amount of prepaid advertising )

Table (1)

• Prepaid advertising is a current asset and it is increased. Therefore, debit prepaid advertising account by $400.
• Advertising expense is a component of stockholders’ equity and it is increased. Therefore, credit advertising expense account by $400.