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    How to determine assets and expenses for accrual and cash basis accounting

    Asked May 16, 2008, 08:16 AM 4 Answers
    I am having a bit of trouble understanding this question in regard to determining assets and expenses for accrual and cash basis accounting:On March 1, 2003, a company paid a $16,200 premium on a 36-month insurance policy for coverage
    Beginning on that date. Refer to that policy and fill in the blanks in the following table:

    This is the table I have come up with:*Policy costs $450 per month.*
    Balance Sheet Insurance Asset Using: ---------------------------------------------- Insurance Expense Using:

    Accrual Basis/Cash Basis----------------------------------------------------------------------Accrual Basis/Cash Basis
    December 31, 2003 16,200, 0-------------------------------------------------------------------------2003 16,200, 0
    December 31, 2004 450, 0-----------------------------------------------------------------------------2004 0, 0
    December 31, 2005 900, 0---------------------------------------------------------------------------- 2005 5400, 0
    December 31, 2006 450, 0-------------------------------------------------------------------------------2006 900, 0
    --------------------------------------------------------------------------------------------------------------Total 22,500, 0

    Can anyone tell me if I am even on the right track with this answer?

    Last edited by abeeson01; May 16, 2008 at 09:19 AM.
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    moonkhan's Avatar
    moonkhan Posts: 32, Reputation: 1
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    #2

    Mar 11, 2011, 03:27 PM

    I have the same question and did this with the same way, but my data is little different. BUT CONFUSED AND DON'T KNOW IF IT IS RIGHT WAY TO DO IT OR NOT. Please check it and let us know if we are at right track or not . Thanks
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    pready's Avatar
    pready Posts: 3,048, Reputation: 199
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    #3

    Mar 12, 2011, 11:26 AM

    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.
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    moonkhan's Avatar
    moonkhan Posts: 32, Reputation: 1
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    #4

    Mar 12, 2011, 02:47 PM
    Quote Originally Posted by pready View Post
    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
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    pready's Avatar
    pready Posts: 3,048, Reputation: 199
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    #5

    Mar 12, 2011, 04:13 PM

    Mar 1, 2003 purchased insurance for 36 months = $450 a month.

    Year 1, Dec 31, 2003 insurance expense will be $4,500 and your remaining Prepaid balance will be $11,700

    Year 2, Dec 31, 2004 insurance expense will be $5,400 and your remaining Prepaid Insurance will be $6,300

    Year 3, Dec 31, 2005 insurance expense will be $5,400 and your remaining Prepaid Insurance will be $900

    Beginning year 4 you have 2 months of insurance because you have used 34 of 36 months or $450 a month + $450 a month = $900 or 2 months of insurance left in Prepaid insurance.

    on March 31, 2003 you purchase an insurance policy for 36 months, which means it will expire on 28 Feb, 2006. Which is in Jan and Feb of year 4, which also means you have 2 months of unexpired insurance or $900.
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