Ultimate guide to prepaid expenses: definition & examples

BlackLine Account Reconciliations, a full account reconciliation solution, has a prepaid amortization template to automate the process of accounting for prepaid expenses. It stores a schedule of payments for amortizable items and establishes a monthly schedule of the expenses that should be entered over the life of the prepaid items. Due to the nature of certain goods and services, prepaid expenses will always exist. For example, insurance is a prepaid expense because the purpose of purchasing insurance is to buy proactive protection in case something unfortunate happens in the future. Clearly, no insurance company would sell insurance that covers an unfortunate event after the fact, so insurance expenses must be prepaid by businesses. Unexpired or prepaid expenses are the expenses for which payments have been made, but full benefits or services have yet to be received during that period.

On the contrary, all accrued expenses have to be reported as a form of current liability on the balance sheet. This is because accrued expenses are costs that the business incurs but has not made the payment for at the end of a financial period. Prepaid expenses are payments made in advance for goods or services yet to be received, but which will be used in the future. Examples of prepaid expenses include prepaid rent, insurance premiums, and annual subscriptions.

Prepaid Expenses Example

” Accrued expenses are common across all lines of business, so you’ve surely come across them or had to deal with them in your business. Are there any benefits to filing taxes for a small business with no income? BlackLine partners with top global Business Process Outsourcers and equips them with solutions to better serve their clients and achieve market-leading automation, efficiencies, and risk control. By outsourcing, businesses can achieve stronger compliance, gain a deeper level of industry knowledge, and grow without unnecessary costs. Whether new to BlackLine or a longtime customer, we curate events to guide you along every step of your modern accounting journey.

The expense is then gradually recognised over the period it is consumed, through an adjusting entry. This means that the expense is spread out over time, rather than being recognised all at once. But, once the amortization schedule kicks in during each respective accounting period, then the adjusting journal entry will impact the income statement and balance sheet. Instead, the value of the good or service must be recognized over time as the business realizes the benefit. In the insurance example, the service provided to the business is liability policy coverage. Each month, the value of this benefit is recognized when the business decreases its prepaid expense account.

Understanding Prepaid Expenses: Examples & Journal Entry

It would be incorrect to charge the whole $4,800 to 2019’s profit and loss account. Fiona Lee is the Head of Content at Ramp, overseeing content marketing, customer education, and customer marketing. She brings over a decade of editorial experience developing high-quality B2B content. Prior to Ramp, she led content teams at companies large and small, including Google and Intercom, where she developed a strong interest in small businesses growth topics.

Prepaid expenses are an asset because the business has not realized the value of the good or service when cash initially exchanges hands. As the benefits of the prepaid expenses are availed over time, they are recorded in the income statement. Prepaid expenses are assets that can be found in a balance sheet that can be extracted from advance payments received from goods and services to be offered by a business in the future. A best practice is to not record smaller expenditures into the prepaid expenses account, since it takes too much effort to track them over time.

Prepaid Expense Example

A prepaid expense is an expense that has been paid for in advance but not yet incurred. In business, a prepaid expense is recorded as an asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. Organizations typically use a prepaid expense ledger to monitor the total amount of money spent on prepayments, when payments are due, and when they will be received. This helps ensure that companies are accurately accounting for their assets while also staying up-to-date with any upcoming liabilities. Prepaid expenses are recorded as an asset on a company’s balance sheet because they represent future economic benefits.

If a company decides to pay for a product or service in advance, the upfront payment is recorded as a “Prepaid Expense” in the current assets section of the balance sheet. Prepaid expenses are recorded within the prepaid asset account of the balance sheet because it signifies a benefit that can be availed in the future. These expenses are considered assets because it provides economic value to the business in the future. Generally, the amount of prepaid expenses that will be used up within one year are reported on a company’s balance sheet as a current asset.

Not adjusting prepaid expenses at the end of the accounting period

The business records a prepaid expense as an asset on the balance sheet because it represents a future benefit due to the business. As the benefits of the good or service are realized over time, the asset’s value is decreased, and the amount is expensed to the income statement. Prepaid expenses are expenses a company pays in advance for products and services. Once the expense is incurred, the company then recognizes an expense on the income statement. The most common prepaid expenses for services are payments for insurance, utilities, and retainers.

BlackLine solutions address the traditional manual processes that are performed by accountants outside the ERP, often in spreadsheets. Retailers are recalibrating their strategies and investing in innovative business models to drive transformation quickly, profitably, and at scale. Save time, reduce risk, and create accounting for research and development capacity to support your organization’s strategic objectives. BlackLine’s foundation for modern accounting creates a streamlined and automated close. We’re dedicated to delivering the most value in the shortest amount of time, equipping you to not only control close chaos, but also foster F&A excellence.

Connect With a Financial Advisor

Transform your order-to-cash cycle and speed up your cash application process by instantly matching and accurately applying customer payments to customer invoices in your ERP. Although Mr. John’s trial balance does not disclose it, there is a current asset of $3,200 on 31 December 2019. These are the company’s cash in bank accounts, received but undeposited checks, savings and money market accounts, and liquid investments such as Treasury bills. Companies prepay many other types of expenses, including taxes, utility bills, rents, insurance, and interest expense. According to the terms and conditions, the current year’s full rent must be paid in advance, which is ₹1,80,000. Vendors and suppliers also benefit from the interest-free use of your company’s funds.