Illustration 7 of final accounts of sole proprietorship Prepaid insura...
&L account
Prepaid expenses are those expenses that have been paid in advance for a future period. For example, if a business pays rent for the next six months in advance, this amount would be considered a prepaid expense.
In the final accounts of a sole proprietorship, prepaid expenses are shown as an asset on the balance sheet and are deducted from the relevant expense in the profit and loss (P&L) account.
Illustration 7:
Let's say that a business paid $12,000 for rent for the next six months in advance. In the P&L account, the rent expense for the year would be recorded as $24,000. However, since half of this amount has already been paid in advance, the prepaid rent expense of $12,000 would be deducted from the total rent expense in the P&L account, resulting in a net rent expense of $12,000.
In this case, the prepaid expense of $12,000 would be shown as an asset on the balance sheet under the heading "Prepaid Rent".
Therefore, the final accounts of the sole proprietorship would show the following:
Profit and Loss Account:
Rent Expense: $24,000
Less: Prepaid Rent: ($12,000)
Net Rent Expense: $12,000
Balance Sheet:
Current Assets:
Prepaid Rent: $12,000
It is important to note that the prepaid expense will be gradually expensed over the period to which it relates. In this case, the prepaid rent of $12,000 will be expensed over the next six months at a rate of $2,000 per month.
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