Question

The following journal entry was made by your predecessor to record the annual payment on a 5-year lease of office space: Rent Expense 12,000 Prepaid Rent12,000 What is the effect of this journal entry on the financial statements?

1) Increase in assets and increase in expenses
2) Increase in assets and decrease in liabilities
3) Increase in expenses and decrease in assets
4) Increase in liabilities and decrease in assets

Answer 1

The effect of the journal entry given is an increase in expenses (Rent Expense) and a decrease in assets (Prepaid Rent), which corresponds to option 3) Increase in expenses and decrease in assets on the financial statements.

Step-by-step explanation:

The effect of this journal entry on the financial statements is an increase in expenses and decrease in assets.

When the rent expenses of $12,000 are recorded, the expenses on the income statement increase, reducing the company's net income. Simultaneously, the prepaid rent account, representing an asset, decreases by $12,000 on the balance sheet.

The journal entry made by your predecessor that debited Rent Expense for $12,000 and credited Prepaid Rent for $12,000 records the payment for office space. As per this journal entry, the effect on the financial statements would be an increase in expenses and a decrease in assets. The Rent Expense account is increased showing that the company has incurred an expense. Simultaneously, Prepaid Rent, an asset account, is decreased because the payment reduces the amount of prepayment for future rent.