TT4 Prepayment of Office Rent and Insurance

Typical Transaction 4

Example: 15,600 Additional Rent and Insurance Prepayment

The entries for this transaction in the Accounting System can be seen here, in the AccountingLab and in the Accounting System, Operations 7 and 48:

Accounting Equation
Prepayment for Office Costs and Insurance Decrease Asset (Cash at Bank) (-)
Increase Asset (Prepayments) (+)
> Enter additional Prepayment expense, three months rental 12,000 plus one year insurance,3,600, total 15,600 in field: “Prepayment”
> Double entry: Debit entry, Debtors and Prepayments balance increases from 9,300 to -24,900. Credit entry, Cash at Bank balance decreases from -767,850 to 742,950
> Values in red show Balance sheet values before and after changes
Balance Sheet Y1
Balance Sheet
Original After Changes
Current Assets  767,850  767,850
Bank 758,550 742,950
Debtors and Prepayments 9,300 24,900
Other Current Assets (Stock)  0  0
Fixed Assets 44,000 44,000
TOTAL ASSETS 811,850 811,850
Current Liabilities  44,300  44,300
Creditors  44,000  44,000
Accruals 300  300
Long Term Liabilities  0  0
Long Term Loan 0  0
Equity  767,550 767,550
Shareholders’ Equity 800,000 800,000
Income Statement -32,450 -32,450
TOTAL Liabilities + Equity + Retained Earnings 811,850 811,850

An analysis of financial ratios can be seen here.

Current ratio calculations are as follows:
Calculation of Current Ratio
Cash at Bank 3 months rent Debtors and Prepayments Current Assets Liabilities Current Ratio
Balance Sheet Original 758,550 9,300 767,850 44,300 767,850 / 44,300 = 17.3
Balance Sheet New 742,950 24,900 767,850 44,300 767,850 / 44,300 = 17.3

The increase in prepayment does not change the current ratio as Cash at Bank diminishes by 15,600 but simultaneously Debtors and Prepayment increases by the same amount. In the Accounting system it can be seen that the entries for this typical transaction are both on the asset side on the B/S, without any change on the liabilities and equity side. Therefore, Current Assets do not change.

Creditors nor Accruals change, thus, Current Liabilities do not change. Current ratio remains the same before and after this transaction.

However, a higher expense in prepayments may cause a cash problem Cash at Bank has been reduced from 758,550 in the initial B/S down to 742,950 in the new B/S, if there are pending payment obligations and the cash is diverted to higher prepayments. Prepayments need careful cash monitoring to avoid running into cash deficit problems.