Question
Prepaid expenses at the beginning of the year relates to security fees that was
paid in the previous financial year. As per the contract with ADL, security fees
are payable half yearly in advance on 1 July and 1 January respectively. The
security fee contract also makes provision for an annual increase on 1 July of
paid in the previous financial year. As per the contract with ADL, security fees
are payable half yearly in advance on 1 July and 1 January respectively. The
security fee contract also makes provision for an annual increase on 1 July of
Ask by Boone Phillips. in South Africa
Mar 31,2025
Upstudy AI Solution
Tutor-Verified Answer
Answer
At the beginning of the year, the prepaid expense covers security fees paid in the previous year. Since fees are paid half-yearly in advance on 1 July and 1 January, the initial prepaid amount applies to the first six months. On 1 July, the security fee increases by 15% of the monthly premium. The new semiannual payment reflects this increase, and the prepaid expense is amortized over six months.
Solution
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Identify the Payment CycleThe contract states that security fees are payable half‐yearly in advance on both 1 January and 1 July. This means that each payment covers the security fees for the next six months.
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Determine the Prepaid Expense from the Previous YearIf the prepaid expense at the beginning of the current year relates to security fees paid in the previous financial year, it likely represents the portion of a semiannual payment that applies to the current year. For example, if a payment was made on 1 July of the previous year for the period 1 January to 30 June of the current year, then the amount applicable to that six‐month period is recorded as a prepaid expense at the beginning of the current year and will be expensed over that period.
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Account for the Annual IncreaseThe contract provides for an annual increase on 1 July of
of the monthly premium. This increase affects the fee payable for the six‐month period starting 1 July. Thus, the new monthly fee from 1 July onward becomes The payment made on 1 July will therefore cover six months at the increased monthly fee. -
Amortization of Security FeesFor accounting purposes, the prepaid expense is amortized (or recognized as an expense) over the benefit period. If the prepaid expense from the previous year covers the period from 1 January to 30 June, then each month’s expense isSimilarly, after the increase on 1 July, the expense for each of the next six months is based on the new monthly fee calculated above.
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Summary of the Treatment
- The prepaid expense at the beginning of the year represents the security fees for the first six months that were paid in the previous financial year.
- On 1 July, the fee increases by
on the original monthly premium. The new semiannual payment made on 1 July will reflect this increased amount. - Amortize each semiannual payment over six months in the financial statements:
- For the first six months (prepaid cost carried over), use the original monthly fee.
- For the second six months, use the increased monthly fee.
This step‐by‐step breakdown shows how to account for the prepaid expense and adjust for the annual fee increase as specified in the contract.
Answered by UpStudy AI and reviewed by a Professional Tutor
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Simplify this solution The Deep Dive
The practice of paying security fees in advance is quite common in many businesses to ensure coverage and services for a specific period. This not only streamlines budgeting but also locks in rates, safeguarding against sudden price hikes. In your case, the annual increase of 15% every July may mean that budgeting will also need to be adjusted, creating a unique opportunity to analyze overall expenses over time and plan for future increases.
When dealing with prepaid expenses, it’s crucial to accurately account for the expense allocation throughout the year. Common mistakes include misclassifying prepaid expenses as current expenses or overlooking adjusting entries at the year-end. A helpful tip is to maintain a schedule for your prepaid expenses, detailing when the payments are made and when they should be recognized as an expense. This ensures that financial statements reflect the true costs associated with operations.
