1. Explain the need for an adjusting entry in the reporting of prepaid expenses and be able to prepare that adjustment.
2. Explain the need for an adjusting entry in the reporting of accrued revenue and be able to prepare that adjustment.
3. Describe the difficulty of determining when the earning process for revenue is substantially complete and discuss possible resolutions.
Question: The second adjustment to be considered here involves the handling of prepaid expenses. In the
transactions that were recorded in the previous chapter, Journal Entry 10 reported a $4,000 payment made in
advance for four months of rent to use a building. An asset—prepaid rent—was recorded through the normal
accounting process. This account is listed on the trial balance in Figure 5.1 “Updated Trial Balance”. Why might
a year-end adjusting entry be needed in connection with a prepaid expense?
Answer: During these four months, the Lawndale Company will use the rented facility to help generate revenue.
Over that time, the future economic benefit established by the payment gradually becomes a past benefit. The asset
literally changes into an expense day by day. For illustrative purposes, assume that one month has now passed
since the original payment. This month of benefit provided by the rent ($1,000 or $4,000/four months) no longer
exists; it has been consumed.