Prepaid expenses in cash basis year carried over to accrual?

One response

1. Yes, your understanding of the transition from cash basis to accrual basis Accounting in this scenario is correct.

   When you purchased the software on 11/1/24 for $24,000 and fully expensed it in 2024 under the cash basis, that means you recorded the entire amount as an expense in that year. However, since you’re switching to accrual Accounting starting 1/1/25, you need to recognize that this software represents a prepaid expense that will be utilized over a period of time.

   Here’s how you would handle the transition:

   1. Adjusting Entry on 1/1/25:
   2. You need to recognize the prepaid expense that reflects the future benefit you’ll get from the software. Since the software has a useful life (assumed to be 12 months for this example), you’ll set up a prepaid asset for the unamortized portion, which is essentially the remaining cost to be recognized over the months.

   3. You would typically make the following entry:

      • Debit Prepaid Expense (Asset): $20,000
      • Credit Retained Earnings: $20,000

   4. Monthly Expense Recognition:

   5. From January 2025 onwards, you would then expense $2,000 per month to reflect the amortization of the prepaid expense.
   6. Your journal entry each month would look like this:
      • Debit Expense: $2,000
      • Credit Prepaid Expense: $2,000

   This way, over the course of 10 months, you will fully recognize the expense related to the software.

   It’s important to ensure that you document your adjustments appropriately, as these entries clarify your transition to accrual Accounting and maintain accurate financial reporting.

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