 Zero Accounting Software 2023, adjusting entry related to prepaid insurance and insurance expense. Get ready to become an accountant hero with Zero 2023. First a word from our sponsor. Well, actually these are just items that we picked from the YouTube Shopping Affiliate Program, but that's actually good for you. Because these aren't things that we're just given to us from some large corporation which we don't even use in exchange for us selling them to you. These are things that we actually researched, purchased and used ourselves. Bayer Dynamic? Not sure if I said that right, but this is the DT770 Pro 250 OHM Studio Reference Closed Back Headphones. I wear headphones basically every day for a large part of the day. They are important to me. Therefore, I've gone through many different kinds of headphones. I've had these for some time and they've worked quite well. They fit over my ears, but I'm still able to put my glasses on under the headphones. 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Courses which are well organized have other resources like Excel files and PDF files to download and no commercials. Here we are in our custom zero home page going into the company file. We set up in a prior presentation, get great guitars. We're going to duplicate some tabs to put reports in like we do every time. Right click on the tab up top so we can duplicate it. Right click on the tab up top so we can duplicate it. Back to the tab to the middle. Accounting drop down, opening up the balance sheet. We're looking at a comparative balance sheet. If you don't have that, you can open the normal balance sheet tab and to the right accounting drop down going to the income statement. We're looking at a comparative income statement. If you don't have that, you can open the standard income statement. Back to the tab to the left. We're looking at another adjusting entry. Remember that adjusting entries are entered as of the cutoff date. That is the end of the month or year for us February 28th. Oftentimes you might do adjusting entries at the end of the year for financial statement reporting purposes or possibly for tax reporting purposes. We're going to be doing adjusting entries based on an accrual accounting concept, but you might do similar kind of things for adjustments for tax preparation and having a tax basis in essence for example. So now we're going to look at this prepaid asset type of thing, the most common example being prepaid insurance. But it's quite similar to the furniture in fixtures or the fixed assets or depreciable assets. So let's just first take a quick look at that and apply then we'll apply the same concept or theory to the insurance. Now, when you have fixed assets, for example, if you purchase like a building, even if you pay cash for it, you're going to have to put it on the books as an asset typically, even if on a cash based system, because there's such a huge difference between the time that you actually bought the building and when you're going to consume the building. And that really demonstrates why the accrual concept is typically is better. Generally, if you could be on a cruel concept, even though it's a little bit more difficult and that is because we're trying to match up the consumption of the use of the building in order to generate revenue. If on the if, for example, I wrote off building expense for 100,000 in January and then compared by January income statement to February. January would look like I had a very, very bad month compared to February, but I didn't. I really had that possibly the same month. It's just that I bought this big piece of equipment and that kind of highlights quite drastically, you know, the principle that we need to have the expenses applied to the same period that they have been incurred. And that's why we have to put the assets on the books as an asset and then we're going to depreciate those assets over the useful life. Now, with depreciable assets, we have to use another account to do that. And one reason we do that is because it's just an estimate. The building does not actually have less building next. We still have one building. It's just deteriorating over time. And therefore we put another account kind of indicating to people, hey, look, this is an estimate. We don't need to do that with other prepays because usually there's going to be an indication to tell us exactly how much we consumed. So prepaid insurance is the same concept. And prepaid insurance is the other big prepayment that's often used as an example. And that's because insurance by its nature means that we bought the insurance before we got anything, right? Because what are we going to get when we get the insurance? And you might think when I get insurance, you might think, well, I only get something from insurance if like an accident happens. I only get something from car insurance if I get in an accident because that's when the insurance company pays out. But that's not the case. You're buying coverage. So the coverage is what you're buying. So as the coverage lapses, you're reducing your risk by having the coverage. As the coverage lapses, then we can reduce the prepaid insurance as it has been consumed. So that's the general concept. You can apply the same concept to anything else that you prepay. If you prepay your rent, then you can do the same thing. It's just that most of the time, often people pay rent monthly or something. Although rent contracts for office buildings are often less regular in their structure than rent contracts for personal rent. So anything that we prepay, we can have a similar kind of concept. Now note that if we didn't have that concept, then people can manipulate their financial statements if they have the cash flow to do so. For example, if I go to the income statement, if you wanted to lower your income statement in order to pay less taxes, let's say, in the United States for an income tax, and you could try to increase your expenses by paying prepayments. You could say, I'm going to pay my rent early. I'm going to pay all my insurance early. And then I'm going to be able to have a timing difference, recording the expense in an earlier period, hopefully trying to lower my taxes. That's manipulating the financial statements that way because you haven't actually incurred the insurance. That's the whole concept of it. And that's why we put it on the books as an asset. And then we have to do this added step of lowering the asset as we go. So just a couple of notes on prepaid insurance. You might pay the insurance monthly. If you pay it monthly, it might not be worth your time to put it on the books as an asset and then depreciate it as you go. But if you depreciate it or lower it or record the expense as you go, however, if you pay for a year's worth of insurance, it starts to become material. It starts to become important for decision making. It will distort your income statements if you don't do the whole prepaid insurance. Also note that if you're doing adjusting entries at the end of the year, you might have a bookkeeper that recorded all the insurance to a prepaid insurance account. That's like the customary way to do it to make it easy. But they may not have. They might have just expensed all of the insurance. If they expensed all the insurance, then you might still do a period in adjusting entry. It would just kind of be the opposite. You would have to reduce the expense and record the prepayment for the amount of the prepayment that has not yet been consumed. The reason we typically put these on the books as a prepayment originally and then do an adjusting entry reducing the prepayment is because one, that's the normal flow that should happen, because when you first buy it, it has not yet been consumed. And two, it's a little bit easier to do the adjusting entries that way, because this is a permanent account. So it doesn't close out to retained earnings at the end of the year. Therefore, it's a little bit easier to track this account and lower it than it is dealing with an expense account, which will close out automatically at the end of the year. And that kind of messes up the adjusting entry. So from a bookkeeping standpoint, you have a decision to make. You're going to be like, OK, for the prepaid insurance, I want to make this as easy as possible. What would be the easiest thing to do in a bookkeeping side of things? Have it paid automatically with your bank feeds and then allocate it to just one account, so that I can automate the transactions. Now, you could just automate that to the expense account. And that would be fine if you don't have to deal with this adjusting entry at the end of the year. But if you have to deal with an adjusting entry, you might just record everything to prepaid insurance and then make that adjusting entry either yourself or by the tax preparer or accountant that's putting together the year-end adjusting entries. All right, so the actual adjusting entry, we're going to assume that one month has passed. So if we were to actually calculate the prepaid insurance, we would get the plan. For the insurance plan, we would see how long the coverage is for and how much we paid for it. So we're going to imagine we pay $12,000. At the beginning of February, let's say, and it's covering 12 months. So how much have we consumed then to make this nice and easy? $12,000 divided by 12, the monthly amount would be $1,000. So we're going to assume that as of February, we have consumed $1,000 of the insurance. Therefore, we're going to lower this amount by $1,000 and record the related expense. What's going to be left then? $1,000 times $11,000 or $11,000, 11 months which have not yet been consumed on that side. All right, so let's do it. We're going to go to the first tab to do it. We'll do a journal entry, hitting the drop down. And we're going to go into the reports to get into our manual journal entries. And we're going to go in here and say, this is going to be journal entries, journal entries, where's the womanly journal entries? Where's the womanly journal entry? I don't know. Let's not get into that. Let's go into the, let's go into add a new journal and this is going to be an adjusting entry, an adjusting entry. And we're going to say this is as of the end of FEB, FEB 28, FEB 28, because that's the date that all of our adjusting entries are for. This will not be a reversing entry. So we're not going to do any reversing entry. Why? Because this is what we call a permanent difference. It's not a timing difference. So it's not like, so because it's not like we're going to get the insurance back, right? We're not just doing a timing type of thing. It's going to be a permanent change that's happening that we're going to record periodically. All right, we're going to say then the adjusting entry is going to be for insurance. Do we have an insurance account? We do. There's the insurance expense. Easy enough, $1,000 on the expense side and then the credit's going to go a prepaid insurance. That's it. And that's all you've got to do. That's all you've got to do. And so what will this do? It'll decrease the insurance account, leaving it at 11,000 from the 12,000 for the prepaid insurance and it'll increase the insurance expense lowering the net income. So let's post it and check it. Posting it and then checking it. Back to the balance sheet update so we can see it up to the date. And then we're going to go down and say prepaid insurance is now down to 11,000 out of February 28th. So if I go into that and we check it on out, check it on, check it on, check it on out. We've got it, we've got the journal entry. Now note, you might ask, you might say, well, yeah, well, I mean, what about the day before February? February 27th, we had used 27 days of the inventory. My reports are not quite right as of February 27th. And we're going to say, yes, that's true. Why don't I allocate like 1,000 divided by 28 days? Why don't I allocate $35.71 per day for the month? That would be more, that would be more correct. So you'd be correct more of the time. Yes, but that's tedious to do. And that's the point here. So we're just going to, we're going to make these periodic adjustments at the end of the period. So the whole point is I'm trying to streamline everything, making the data input as easy as possible, pulling the information in from the bank account, plugging it into prepaid insurance and just making the adjustments periodically, usually at the end of the month or the end of the year as needed, sacrificing the fact that the middle of the month may not be perfectly adjusted and that's fine. So we're going to go to the tab to the right, update this again. And then if we go on down, we could say we should have insurance down here. Right there, there it is. Insurance has been recorded for February. We're going to say that we went without insurance for January. We recorded the adjusting entries as of the end of February and so on. And you can see why that's important. Note, if I recorded all the insurance in January, even though I didn't have it covered until February, then I would have a distortion of my net income, right? And recording it this way should be more comparatively accurate to kind of judge actual performance between January and February. All right, so that's it. Let's go to our trial balance and check out where we stand at this point in time, hit the dropdown in the accounting reports and we'll type in the trustee trial balance. Not trustee, but trial balance. Trustee is just what it is. I don't type in trustee because Zero doesn't call it that. But it is trustee. I trust the trial balance more than most human beings by far updating it. There it is. Okay, so this is where we stand if, wait a sec. Yeah, that's fine. I'm running it through March. Maybe I should do it as of the cutoff. But I'll just do it for the whole thing so you can see kind of where we stand, including the stuff that we entered in March. So this is where we are, just so you can check your numbers. And if your number's tied out last time and not this time, we of course made a change to the prepaid insurance and we made a change to the insurance expense, classic adjusting entry, having one balance sheet account, one income statement account to it.