Analyze Accounts to Separate Mixed Costs into Variable and Fixed Components
Scattergraph to Separate Mixed Costs into Variable and Fixed Components
Tax-Deductible Expenses for Micro-Entrepreneurs

Set-Up and Follow-Up Transactions for Revenue and Expenses

Set-up and follow-up transactions are supporting transactions for the profit-making activities of a business that take place before or after revenue and expenses are recorded. These set-up and follow-up transactions are necessary, as you can see in the following examples:

  • Buying products for inventory (the goods are held in inventory until they’re sold and delivered to customers)

  • Collecting receivables from customers

  • Paying liabilities for products, supplies, and services that were bought on credit

  • Paying certain expenses in advance, such as for insurance policies, shipping containers, and office supplies

Profit-making activities are reported in the income statement, and investing and financing activities are reported in the statement of cash flows. In contrast, set-up and follow-up transactions for revenue and expenses aren’t reported in a financial statement.

These housekeeping activities have financial consequences and must be recorded in the accounts of a business. Although no revenue or expense account is involved in recording these activities, these transactions change assets and liabilities.

As an example, a business purchases fire insurance on its building and contents. The insurance policy covers the next six months. The business writes a check for $25,000 to the insurance company. Also, the business recently purchased $328,000 of products for inventory on credit. The products were delivered to the company’s warehouse, and after inspection, the company accepted the products.

The journal entries for the two transactions are as follows:

Account Debit Credit
Prepaid Expenses $25,000
Cash $25,000

The cost of insurance policies is entered in the asset account called prepaid expenses. Over the six months of insurance coverage, the cost is allocated to insurance expense. The payment for the insurance policy decreases one asset (cash) and increases another asset (prepaid expenses).

Account Debit Credit
Inventory $328,000
Accounts Payable $328,000

The purchase of products doesn’t result in an expense; rather, the transaction is the acquisition of an asset called inventory. The cost of products remains in the asset account until the products are sold to customers, at which time the cost of goods sold expense is recorded, and the asset inventory is decreased. Because the purchase was made on credit, the liability accounts payable is credited (increased). When this liability is paid later, the account is debited (decreased), and cash is decreased.

blog comments powered by Disqus
Accounting: Examining Both Sides of Business Transactions
How to Estimate Inventory with the Gross Profit Method
Notes Receivable Issued at Other Than Face Value
Keeping the Accounting Equation in Balance
Special Depreciation Issues in Intermediate Accounting