Deferrals — cash moved first, adjust later
Two December 31 adjustments: the studio paid $1,200 on Oct 1 for 12 months of insurance (3 months now used), and it received $600 on Dec 1 for a 3-month project (1 month now earned). Prepare both adjusting entries.
The journal entry
Dec 31: 3 of 12 insurance months used (1,200 × 3/12)
| Account | Debit | Credit |
|---|---|---|
| Insurance Expense | $300 | |
| Prepaid Insurance | $300 |
- Insurance Expense (debit): Oct–Dec's coverage is consumed — 3/12 of the 1,200 becomes expense.
- Prepaid Insurance (credit): The asset shrinks from 1,200 to 900 — exactly the unused months remaining.
Remember this
- formula
Deferral = cash FIRST, income effect LATER. Prepaid: Dr Expense / Cr the prepaid asset (used slice). Unearned: Dr Unearned Revenue / Cr Revenue (earned slice). Slice = amount × time used ÷ total time.
- watchout
Adjusting entries never include Cash. If you've written Cash in an adjustment, it isn't an adjustment.