Question

Understanding the Business Transaction A business will sometimes pay for a service or other benefit in advance of its actual use. Paying for a service in advance of use is called. This type of business transaction occurs because the service is more efficiently purchased initially in aggregate, then later consumed over time. Paying for the same service as it is consumed may not be efficient. Examples of services that are purchased in aggregate prior to consumption include season tickets, insurance, rent, subscriptions, and supplies. In the case of insurance, a business will typically purchase six months’ or a year’s insurance in advance. As the time passes, the benefits of the policy are used (consumed). At the end of the insurance period, the benefit is completely consumed and the business transaction repeats for another period of time. This transaction approach is often more efficient than paying for insurance month by month. An adjusting entry is necessary for this type of transaction in order to recognize the amount of service that has been consumed by the end of an accounting period.



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