Please I need a correct answer and clear explanation Thanks

Please, I need a correct answer and clear explanation. Thanks,

Explain how a prepaid expense differs from an accrued expense.

Solution

Basic point of differentiation between Accrued expenses and prepaid expenses is: timing of the expense incurred

Prepaid expenses are, as the name suggests (pre PAID), those expenses where payment for a service is made in advance but service is to be availed in future period. Prepaid expenses are shown under Assets.

Accrued expenses are exact opposite of prepaid expenses. Accrued expenses are those expenses where service is already availed but payment is not yet made. Accrued expenses are shown under Liabilities .

Following table will clear all your confusion:

Example of prepaid expense:

Suppose you paid $1200 gym membership for full year in the first month.

Here you haven\'t availed gym services for remaining 11 months but have made payment for the same hence Gym membership fees for 11 months i.e. $1100 will be prepaid expense (Asset) in the first month.

Entry for 1st month:

Prepaid expenses (Asset) Dr 1100

Gym membership fees (Statement of profit & loss) Dr 100

To Cash Cr 1200

In 2nd month you will move portion of prepaid expense for 2nd month i.e. $100 from prepaid expenses (Assets) to statement of profit and loss. Thus balance in prepaid expenses (Assets) will be only for 10 months at the end of second month ($1000).

Entry:

Gym membership fees (Statement of profit & loss) Dr. 100

To Prepaid expenses (Asset) Cr. 100

Prepaid expense balance at the end of second month will be $1000

Example of Accrued expense:

Salary of employees for a month is paid on the 5th day of next month . Here, you have availed services of employees in current month but payment is made in next month.

Hence salary for current month is accrued and accounting entry will be:

Salary ( Statement of profit and loss acount) Dr

To Accrued expenses (Liabilities) Cr