On April 1, Santa Fe, Inc. paid Griffith Publishing Company $1,548 for 36-month subscriptions to several different magazines. Santa Fe debited the prepayment to a Prepaid Subscriptions account, and the subscriptions started immediately.
-What adjusting entry should be made by Santa Fe, Inc. for the adjustment on December 31 of the first year assuming the company is using a calendar-year reporting period and no previous adjustments had been made?

Question

On April 1, Santa Fe, Inc. paid Griffith Publishing Company $1,548 for 36-month subscriptions to several different magazines. Santa Fe debited the prepayment to a Prepaid Subscriptions account, and the subscriptions started immediately. 
-What adjusting entry should be made by Santa Fe, Inc. for the adjustment on December 31 of the first year assuming the company is using a calendar-year reporting period and no previous adjustments had been made?

Quizplus · Accepted Answer

According to the accrual basis accounting principle, expenses should be recognized when they are incurred, regardless of when they are actually paid. In this case, Santa Fe, Inc. paid for the 36-month subscriptions in advance, but the expense should be recognized proportionally over the period of the subscription. Thus, after the first year, only 1/3 of the prepaid subscription should be recognized as an expense.

The amount of the adjustment can be calculated as follows:
Total prepayment = $1,548
Expense to be recognized in the first year = $1,548/36 x 12 = $516
Amount of prepaid subscription remaining = $1,548 - $516 = $1,032

Therefore, Santa Fe, Inc. should debit Subscription Expense for $387 ($516/3) and credit Prepaid Subscriptions for $387. This will reduce the balance in Prepaid Subscriptions to $1,032, which reflects the remaining prepaid portion of the subscriptions.