Expensing an Invoice for a Full Year of Services

Understanding the Context: A company issues an invoice for 120,000 USD covering services provided from January 1, 2017, to December 31, 2017. This invoice is received on April 2, 2017, and is paid in the same month. The question arises on how to properly expense this invoice within the financial statements.

Accrual Accounting Method

Under the accrual accounting method, expenses are recognized when they are incurred, irrespective of when they are paid. This method is the preferred approach as it ensures financial statements reflect the true economic performance of the business.

Step 1: Recognize the Expense

Since the service period covers an entire year, the full amount of the invoice, 120,000 USD, should be recorded as an expense in the financial records for the year 2017.

Journal Entry:

April 2, 2017 Debit: Expense (e.g., Service Expense) 120,000 Credit: Accounts Payable 120,000

Step 2: Payment of the Invoice

When the invoice is paid on April 20, 2017, the following journal entry is made to reflect the cash payment:

April 20, 2017 (date of payment) Debit: Accounts Payable 120,000 Credit: Cash/Bank 120,000

Step 3: Reporting on Financial Statements

The expense of 120,000 USD will appear in the income statement for the year 2017, representing the cost of services received during that period. This ensures that the financial statements accurately reflect the expenses incurred during the period in which the services were provided.

Prepaid Service Account Approach

Assuming that the invoice was anticipated and a "prepaid service account" was set up, the following approach could be used:

Step 1: Set Up a Prepaid Service Account

Funds are accrued at a monthly rate of 10,000 USD for the months of January to March when the service is not yet received, meaning you would have accrued 30,000 USD as prepaid services:

Journal Entry:

January 1, 2017 to March 31, 2017 Debit: Prepaid Services 10,000 Credit: Cash/Bank 10,000 Repeat for January, February, and March

Step 2: Pay the Invoice and Adjust the Prepaid Account

In April, the invoice is paid from the prepaid account:

Journal Entry:

April 20, 2017 (date of payment) Debit: Accounts Payable 120,000 Credit: Prepaid Services 30,000 Debit: Service Expense 120,000 Credit: Prepaid Services 90,000

Step 3: Monthly Debits and Credits

Each month thereafter, when the service is received:

Journal Entry:

May, June, July, etc. Debit: Service Expense 10,000 Credit: Prepaid Services 10,000

Summary

Using the accrual accounting method, you recognize the expense of 120,000 USD in 2017 as the invoice pertains to services provided throughout that year. This ensures that your financial statements accurately reflect the expenses incurred during the period in which the services were provided. If a prepaid account was used, the preparation and adjustments would be more detailed but ensure accurate accounting and financial reporting.