Prepaid expenses at the beginning of the year relates to security fees that was
paid in the previous financial year. As per the contract with ADL, security fees
are payable half yearly in advance on 1 July and 1 January respectively. The
security fee contract also makes provision for an annual increase on 1 July of
of the monthly premium.

Question

Prepaid expenses at the beginning of the year relates to security fees that was
paid in the previous financial year. As per the contract with ADL, security fees
are payable half yearly in advance on 1 July and 1 January respectively. The
security fee contract also makes provision for an annual increase on 1 July of

of the monthly premium.

UpStudy AI · Accepted Answer

1. **Identify the Payment Cycle**

The contract states that security fees are payable half‐yearly in advance on both 1 January and 1 July. This means that each payment covers the security fees for the next six months.

2. **Determine the Prepaid Expense from the Previous Year**

If the prepaid expense at the beginning of the current year relates to security fees paid in the previous financial year, it likely represents the portion of a semiannual payment that applies to the current year. For example, if a payment was made on 1 July of the previous year for the period 1 January to 30 June of the current year, then the amount applicable to that six‐month period is recorded as a prepaid expense at the beginning of the current year and will be expensed over that period.

3. **Account for the Annual Increase**

The contract provides for an annual increase on 1 July of $$15\%$$ of the monthly premium. This increase affects the fee payable for the six‐month period starting 1 July. Thus, the new monthly fee from 1 July onward becomes

$$
   \text{New monthly fee} = \text{Original monthly fee} \times \left(1 + 0.15\right)
   $$

The payment made on 1 July will therefore cover six months at the increased monthly fee.

4. **Amortization of Security Fees**

For accounting purposes, the prepaid expense is amortized (or recognized as an expense) over the benefit period. If the prepaid expense from the previous year covers the period from 1 January to 30 June, then each month’s expense is

$$
   \text{Monthly expense (prepaid portion)} = \frac{\text{Amount prepaid}}{6}
   $$

Similarly, after the increase on 1 July, the expense for each of the next six months is based on the new monthly fee calculated above.

5. **Summary of the Treatment**

- The prepaid expense at the beginning of the year represents the security fees for the first six months that were paid in the previous financial year.
   - On 1 July, the fee increases by $$15\%$$ on the original monthly premium. The new semiannual payment made on 1 July will reflect this increased amount.
   - Amortize each semiannual payment over six months in the financial statements:
     - For the first six months (prepaid cost carried over), use the original monthly fee.
     - For the second six months, use the increased monthly fee.

This step‐by‐step breakdown shows how to account for the prepaid expense and adjust for the annual fee increase as specified in the contract.
At the beginning of the year, the prepaid expense covers security fees paid in the previous year. Since fees are paid half-yearly in advance on 1 July and 1 January, the initial prepaid amount applies to the first six months. On 1 July, the security fee increases by 15% of the monthly premium. The new semiannual payment reflects this increase, and the prepaid expense is amortized over six months.

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