Accounting Exam Notes: Expenses, Supplies & Prepaid Expenses

Expense

A cost where the economic benefit is used immediately or during the current accounting period, reported on the Income Statement.

Asset / Capitalization

A cost that provides benefits extending into future accounting periods, reported on the Balance Sheet.

Supplies

Initially recorded as an asset because they have a future economic benefit; become an expense when used.

Supplies Cycle

The process where purchase supplies are recorded as an asset and become an expense upon usage.

Prepaid Expenses

Assets created when cash is paid before receiving the benefit, becoming expenses as the benefit is utilized.

Financial Statement Effects of Supplies Used

Assets decrease, Supplies Expense increases, leading to lower Net Income and Retained Earnings.

Adjusting Entry

An entry that updates accounts without involving cash, such as recognizing a supplies expense.

Insurance Expense

The cost recognized on the Income Statement when the benefit of the insurance is used.

Cash Flow vs. Expense

Cash flow occurs when cash is spent, while expenses are recorded when the respective benefit is consumed.

Impact of Purchasing Supplies with Cash

Cash decreases while Supplies increase; total assets remain unchanged.

Pattern A in Financial Statement Effects

If Assets decrease, Expenses increase, and Cash Flow is NA, it's usually an adjusting entry for an expense.

Pattern B in Financial Statement Effects

If Assets increase or decrease and Cash Flow is negative OA, it's typically the purchase of an asset.

Recognizing Prepaid Insurance Adjustment

Debit Insurance Expense and credit Prepaid Insurance based on the proportion of time the coverage is used.

Calculating Supplies Expense Formula

Supplies Expense = Beginning Supplies + Purchases - Ending Supplies.

True/False: Prepaid Insurance

Prepaid Insurance is not shown on the Income Statement as it is an asset until used.

Year 1 vs. Year 2 Prepaid Insurance

Year 1 recognizes the usage based on the prepaid period, while Year 2 accounts for what's remaining.

Common Exam Trick

If Assets change with no Income Statement effect and negative Cash Flow, it likely indicates the purchase of an asset.

Adjusting Entry Effects

When a prepaid expense is used, it decreases the asset, increases the expense, and impacts Net Income and Retained Earnings.