Accounting Online Program Certification Practice Test

What journal entry should Paul Ltd make to adjust its rental expense for the year ended 31 December 20X1?

1. Debit Rent Expense £500, Credit Prepayments £500

2. Debit Prepayments £500, Credit Rent Expense £500

3. Debit Rent Expense £600, Credit Prepayments £600

4. Debit Prepayments £600, Credit Rent Expense £600

The correct answer is: Debit Prepayments £500, Credit Rent Expense £500

In financial accounting, adjusting entries are necessary to ensure that expenses and revenues are recorded in the correct accounting period. In this case, the adjustment relates to rental expense, which may involve recognizing prepaid amounts that should be allocated correctly. When Paul Ltd needs to adjust its rental expense, debiting Prepayments and crediting Rent Expense indicates that an expense has been over-accrued or not fully realized in the current accounting period. This adjustment suggests that some of the rental expense recognized in the income statement should actually be shifted to a prepaid account, effectively reducing the expense recognized for the period. By debiting Prepayments, the company acknowledges that it has paid rent in advance, which will benefit future periods. Crediting Rent Expense reduces the total expense reported, aligning it with the actual usage of the rental property during the year. This method ensures the financial statements accurately reflect the company’s rental costs for the reporting period and adhere to the accrual basis of accounting, where expenses should only be recognized when incurred in generating revenue, not simply when cash changes hands.