Originally Posted by pready
Cash Basis is simple as you only record transactions that involve cash. Therefore your purchase of the insurance premium your journal entry will be:
Debit Insurance expense for the amount of insurance purchased
Credit Cash for the amount.
Accural basis accounting you record all transactions. You first will record the purchase of insurance as:
Debit Prepaid Insurance for the amount of insurance purchased
Credit Cash for the amount of inusrance ppurcahsed.
At the year end you need to calculate the amount of insurance used during the year.
For year 1 you only used 10 months of insurance so your amount of insurance used will be Cost of the insurance * 10 months used / number of months of the policy, or $16,200 * 10/36 = Insurance Expense for year 1.
Your journal entry will be:
Debit Insurance Expense for the amount calculated above
Credit Prepaid Insurance for the amount calculated above.
Your remaining Prepaid balance at the end of year 1 or the beginning blance for year 2 will be: Cost of Insurance of $16,200 - Insurance Expense during the year (amount calculated above).
For year 2 and year 3 you do the same thing as above except you will be calculating for 12 moths of insurance used during the year instead of 10 months that was calculated for year 1.
To calculate your remaining prepaid balance you take your beginning year balance - insurance expense during the year. Year 2 ending balance and year 3 beginning balance will be your beginning balance year 2 - insurance expense during year 2. Year 3 ending balance and year 4 beginning balance will be year 3 beginning balance - insurance expense during year 3.
Note your ending year 3 Prepaid Insurance balance should be 2 months worth of insurance because during year 1 you used 10 months of insurance, year 2 you used 12 months of insurance and year 3 you used 12 months of insurance, which equals a 36 month policy - 10 months - 12 months - 12 months = 2 months of insurance remaining, or $16,200 * 2/36.
But if follow the above question, you are not left with 2 months, but have to pay more for 10 months, How you will do that. Also can you please check in the above question if the procedure is right or wrong. Thanks