What effect does recording a prepayment at the year end have on the income statement and the statement of financial position?
Question 1 Report
What effect does recording a prepayment at the year end have on the income statement and the statement of financial position?
Answer Details
The correct answer is expenses decrease and current assets increase.
Recording a prepayment transfers part of the cash paid from the expense account to a prepayment account. The portion that relates to a future period is removed from expenses (decreasing them) and recognised as a current asset (increasing current assets).
This correctly reflects that the business has a future benefit (the prepaid service) which is an asset. Without the adjustment, expenses would be overstated and assets understated.
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