Chapter 1
Financial Statements: Personal Accounting
17
So, borrowing and repaying debt principal does not impact net worth, and neither does buying or
selling assets for the value stated in the balance sheet. The primary way you can change your net
worth is to have revenue exceed expenses (net worth increases) or have expenses exceed revenue
(net worth decreases).
Prepaid Expenses
It is a common practice to pay for various expenses in advance, for example, insurance and rent.
These prepayments are not considered an expense at the time they are paid because the services
have not been provided.The example illustrated in Figure 1.31 explains the prepayment of $1,200
for insurance for one year.
2. After one month of
coverage, if the
insurance policy were
cancelled you would
not get your money
back for the month you
have used. This
reduces the value of
the asset.
You will also recognize
the expense for the
one month of services
provided, which
reduces net worth.
Insurance used
2
2
ASSETS
ASSETS
PERSONAL BALANCE SHEET
PERSONAL BALANCE SHEET
LIABILITIES
LIABILITIES
CASH
CASH
PREPAID EXPENSES
PREPAID EXPENSES
HOUSE
HOUSE
AUTOMOBILE
AUTOMOBILE
CONTENTS OF HOME
CONTENTS OF HOME
UNPAID
ACOUNT S
UNPAID ACCOUNTS
MORTGAGE
MORTGAGE
LOANS
LOANS
NET WORTH
NET WORTH
1. - $1,200
1. + $1,200
1. You pay $1,200 to
the insurance company,
which provides you
with coverage for one
year. They will refund a
por on of you money
if you cancel the policy
before the full year is
over.
$1,200
2. - $100
INSURANCE
EXPENSE
2. + $100
No change in net worth
Net worth decreased by $100
______________
FIGURE 1.31
When you prepay your insurance, you might think intuitively that your net worth decreased because
the cash is no longer in your bank account. However, what you have really done is purchase a one
year insurance policy, which you now own. Anything you own and will benefit you in the future
is considered an asset and recorded on the balance sheet. In this case the amount paid for the
insurance policy is considered a prepaid expense. A
prepaid expense
occurs when you pay cash for
an expense (like insurance) before you use it. You own the policy for one year and the insurance
company must provide you with coverage for that period of time. If you cancel the insurance policy
before the year is up, the company will have to refund your money for the amount of the policy
that you did not use.
