Case breakdown: Movie Spiderman
Peter Parker is a photographer for Daily Bugle, NYC tabloid newspaper. As Peter enters in the room, his boss shouts at him and fires him. In the very next moment, re-hires him as there are no photographers available and he wants some fresh photos. In return Peter asks him for advance payment.
What is Advance Payment?
Advance payment, as the name suggests it is a payment that is made prior to the completion of an assignment. Advance payments are taken by many sellers and producers to cover their risk of non-payment by the client.
Example can include, wedding planners, caterers, prepaid electricity providers. These are some of the vendors who ask for advance payments. The balance money is paid to them after the completion of the job.
How is Advance Payment Recorded?
In businesses, it is quite normal to receive and give payments in advance. A business owner can pay rent and insurance in advance and can receive money from clients in advance.
Let’s assume ABC business pays 1 years’ rent in advance on 1st January of Rs. 6,000 (500*12), now in ABC’s books on 1st January the entry would be
Prepaid Rent A/c Dr. 6,000
To Rent A/c 6,000
Prepaid Rent A/c is an asset A/c because for the company rent has been paid for 12 months, there would be an adjusting entry in this because benefit from using the rented space occur evenly over time, with 1 month’s cost attributable to January, February, March and so on.
Therefore, we need to record one month of the asset’s cost as an expense in January and include it in one month’s income statement, along with the revenue it helped to produce.
When closing the month of January, the entry would be:
Rent Expenses A/c Dr. 500
To Prepaid Rent 500
Now let’s assume boss give Peter Parker the advance payment he asked for, how would Daily bugle record it in its books?
Advance Salary A/c Dr. 5,000
To Cash 5,000
Let’s say the company incurs $30,000 in total by the end of the month. Now the adjusting entry would be:
Salary Expense A/c Dr. 30,000
To Advance Salary 5,000
To Cash 25,000
Total salary expenses is $30,000 but the cash outflow would be $25,000 because $5,000 has already been paid to Peter Parker.
Written by: Gitika Chandra