Here is an interesting question for accounting purists I rec

Here is an interesting question for accounting purists... I receive an invoice on Dec 1st for my insurance premium covering the next year. As habit, I code my insurance bill to prepaid expense and pass it on to the payables clerk to into the accounting system. The clerk posts the entry to prepaid and accounts payable. As the accountant, I record the addition to prepaid expense so that I can amortize the appropriate amount of expense each month next year. The company controller who is in charge of releasing payments holds off on remittance due to cash flow issues - and fails to pay the bill until February. Oops! So... is the invoice date for a future period of coverage the most important part of what makes a bill a prepaid expense? Or is the actual remittance of funds that makes it prepaid? How should we address and correctly post this invoice?

Solution

The fact whether an expense is a prepaid expense or not depends on the period of coverage of such expense. Under the given situation, the entry at the time of receiving invoice will be Debit to Prepaid Insurance and Credit to Accounts Payable The entry at the time of payment will be debit to Accounts Payable and Credit to Cash. The preapid insurance account will be monthly amortized over the period of coverage.